By Michael Halloran
Many financial advisors consider the advice they offer to clients on asset allocation to be part of how they add value. Yet, they often fail to see cash as an important asset class to be managed.
In light of the Department of Labor’s fiduciary rule, more advisors are thinking about the advice they provide, including cash held outside the brokerage account.
As noted in a recent CNBC article on the upside of managing cash, smart cash management can increase overall portfolio returns. Just as advisors suggest clients use specialist managers to handle portions of their portfolios (such as fixed income), this can be true for cash as well, for several compelling reasons:
1. Boost returns across the portfolio
Increasing the yields investors earn on their cash can make a material difference in their overall portfolio’s performance depending on the client’s total amount of cash.
According to the Capgemini World Wealth Report, the average high-net-worth household keeps 23.7 percent of its assets in cash. That cash is often earning nearly nothing: on average, retail bank deposits yield a paltry 0.08 percent, according to Bankrate.
Many investors assume that cash is earning little because of today’s prevailing low rates — that’s true for brick-and-mortar banks and brokerage accounts. But online banks, which don’t have to spend money on physical branches, offer rates that can exceed 1.30 percent, FDIC-insured.
The incremental yield that cash earns within online accounts is effectively “alpha” — excess return above that delivered by the market. This enhanced yield can help boost the return of the entire portfolio by more than 25 basis points, assuming typical levels of cash, for a high-net-worth U.S. household. Financial advisors have noted that this improvement takes some of the pressure off the equity and fixed income allocations to perform, and can allow for a lower risk profile as well.
Clients are always going to hold some portion of their assets in cash. It’s the one asset class that all investors share, whether they’re holding it so they can make quick purchases if asset prices fall, or because they have a conservative outlook on the markets. Advisors should ensure this cash is earning as much as possible.
2. Increase FDIC insurance
Because cash held in deposit accounts is fully liquid, it's not at risk unless the bank where it's held fails. That's a remote danger, but one that can be avoided by keeping all deposits below the FDIC insurance limit ($250,000 per depositor, per account type, per institution).
Although the vast majority of Americans hold brick-and-mortar deposit accounts rather than online accounts, online banks are also members of the government’s FDIC insurance program. Deposit insurance gives cash held in an online account the same risk profile as funds held within a brick-and-mortar bank.
To increase a client’s FDIC insurance, some clients may need to open accounts at multiple banks, taking care to stay below the FDIC limits at each bank. Although discrete accounts, these serve effectively as a Separately Managed Account (SMA) for cash.
3. Bring held-away cash into view
Clients often have much more cash than the advisor knows. While many planning-focused advisors use aggregation tools, it’s not uncommon for investors not to share their held-away cash balances with their advisor.
In addition, high-net-worth investors often maintain multiple financial relationships and won’t necessarily tell any one advisor about all their assets. Firms that can deliver a higher yield on cash give clients a reason to bring their cash under that advisor’s purview.
Once an advisor can see total cash levels, it’s possible for her to have a conversation with the client about how the cash can best be deployed. This provides a new way to grow an advisor’s practice by better serving existing clients.
Cash is an integral part of every client’s portfolio. Advisors can meet a fiduciary level of care by helping clients allocate cash to higher returning institutions, such as leading online banks, while keeping it insured and liquid. Clients can sleep better at night and have cash on hand to deploy when attractive opportunities arise.
Michael Halloran is the Head of Partnerships and Business Development at Max, an intelligent cash-management solution for financial advisors and their clients, which helps maximize yields on cash while increasing FDIC coverage. A longtime financial technology executive, he tweets at @fintechblogger.
