Not All Cash Management Options are Created Equal
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What does it mean to have cash and manage it properly? Proper cash management is about having liquidity that you can count on for your emergency fund and your short-term needs. Most of us know better than to put our cash under a mattress, because it’ll only lose value to inflation. And, savings accounts come with too many conditions, which makes it difficult for you to manage your cash properly.
So, you may be considering to put your cash in alternative cash management offerings that give you a rate on your cash while ensuring its liquidity. But not all cash management offerings are the same.
The structure of a cash management offering affects its riskiness
To help you earn a return on your cash, cash management offerings invest your cash in one or more high-quality short-term funds. As these offerings are technically investments, they inherently carry a level of risk.
How risky an offering is depends on the funds it uses to structure its account. These funds, which are cash funds, money market funds, ultra-short duration bond funds, and short-duration bond funds, have different risk levels depending on the what assets make up the fund, the quality and maturities of those assets, and how the fund values its assets.
Your top priority for your cash should always be to ensure its liquidity, and that it isn’t overexposed to risk. That’s why it’s important that you look beyond the advertised rate on an offering to also look at the funds used to structure that offering. When you know how an offering is structured, you’ll have a clearer picture of how much risk your cash is exposed to when you choose an offering.
The table below shows the characteristics of cash funds, money market funds, ultra-short duration bond funds, and short-duration bond funds. In the next section, we’ll cover how these characteristics impact each fund’s risk level.
Table 1: Funds commonly used to structure cash management offerings
The characteristics of a fund in a cash management offering impacts its riskiness
We’ve established that the riskiness of a cash management offering is directly related to the riskiness of underlying funds in that offering. And, as shown in Table 1, the riskiness of a fund comes down to 3 characteristics:
- The type and quality of asset the fund invests in;
- The average maturity of the assets in the fund;
- How the fund values its assets
The type and quality of assets a fund invests in
A fund in an offering can invest in any of these 3 short-term financial assets: 1) bank deposits; 2) money market instruments such as commercial papers and Treasury bills; or 3) short term debt such as government bonds and corporate bonds. Each asset has a different risk level that, in turn, influences the riskiness of a fund.
For instance, a short duration bond fund that holds mostly short-term debt is riskier than a cash fund that holds mostly bank deposits. That’s because a short-term debt issuer could default on its obligations while a bank rarely, if ever, defaults on its deposits.
The quality of the assets matter too; a short-duration bond fund that invests in high-quality bonds is less risky than a bond fund that invests in junk bonds.
The average maturity of the assets in a fund
Funds that use assets with shorter maturities are less risky because the fund will likely get its principal back quicker. Simply put, there’s less time for things to go sideways.
For example, a money market fund (MMF) that invests in assets with a 1-month maturity will get its principal back much quicker than a short duration bond fund that holds assets with a 2-year maturity. Hence, the MMF carries less risk than the short duration bond fund.
How a fund values its assets
How a fund values its assets determines whether that fund has a fluctuating net asset value (NAV).
Some funds that invest in money market instruments and short-term debt value those assets at current market prices. For instance, if a fund buys a short-term bond at $100 SGD today, and that bond’s price goes down to $90 SGD tomorrow, the fund will have to report that $10 loss in their net asset value (NAV). As a result, a fund that values its assets at current market prices has a fluctuating NAV. Consequently, a fund with a fluctuating NAV carries more risk than a fund with a NAV that doesn’t fluctuate.
As you can see from Table 1, most short duration bond funds and some ultra-duration bond funds have a fluctuating NAV. If an offering uses these bond funds, make sure to check that these funds don’t have a fluctuating NAV.
Why does it matter to check to see if a fund has a fluctuating NAV? Because an untimely drop in a fund’s NAV eats into your cash right when you want to use it.
Say you need to use your emergency fund to pay for an unexpected medical bill. If your cash is exposed to a fluctuating NAV, you could end up withdrawing it at a loss to pay off that bill. Even if that loss isn’t substantial, making sure that your cash is always liquid and safe is fundamental to cash management. A fund with a fluctuating NAV goes against that fundamental principle.
Now that you know how the characteristics of a fund affect its riskiness, here’s how the 4 funds mentioned in the table above stack up against each other in terms of their risks and returns.
Table 2: Relative risk and return of each fund
We structure StashAway Simple™ to ensure that your cash isn’t overexposed to risk
We designed StashAway Simple™ with a money market fund and an enhanced liquidity fund (a type of ultra-short duration bond fund). We chose these funds because they both have predictably stable NAVs, which means your cash isn’t overexposed to market conditions.
While short-duration bond funds can yield a slightly higher return, we don’t use them in Simple because their fluctuating NAV overexposes your cash to risk. Remember, you’re holding cash for liquidity purposes, not for capital growth. But if you’re looking for capital growth for the medium-to-long term, you can choose to invest in our lower-risk portfolios that have an allocation to short duration bond funds.
Because we pay close attention to what underlying funds we use for Simple, we’re able to keep Simple’s risk level incredibly low: StashAway Simple™ has a StashAway Risk Index of 1.7%, which means there’s a 99% chance that you won’t lose more than 1.7% of your cash in any given period.