In this week's blog I will discuss managing cash in an environment of record low interest rates. Federal Reserve chairman Ben Bernanke has told congress that record low interest rates are needed to stimulate the economy and to help reduce the high unemployment rate. What are your cash options in such an environment? Dare we dream that it gets like Switzerland in the late 1970s when investors bought negative interest rate Swiss treasury bonds because of the strength of the Swiss franc? (Investors also paid a withholding tax if they had savings in Swiss francs in Swiss banks. This was done to discourage foreigners from holding Swiss francs.)
My intent is to manage my short-term cash reserve which would serve, for example, as my emergency fund (6 to 9 months of my salary), pay for college expenses due in the next 6 to 9 months, or be earmarked for a new car or house that I will buy in the next 6 months. I would like to try to get the best rate of return with little or no risk to my investment. For this blog let’s use the following example, I have a $50,000 cash emergency fund to help pay my expenses if I were to lose my job. How do I get the best return with little or no risk? Should I have just one investment vehicle or several diversified investment vehicles? This is not the mid-2000s when you could get a 5% interest rate from e-Trade for an investment account (i.e. savings) that was risk free since it had FDIC insurance (and you did not exceed $100,000 in the account).
Let’s review different investment types (all rates from the week of August 9, 2010):
• Savings account: For Bank of America's (B of A) Growth Cash Maximizer program ($5,000 minimum daily balance required) the standard interest rate is .15% for less than $10,000 and .4% for $25,000 up to $50,000. If you do certain transactions with B of A you can be in the rate bonus plan that will pay you .65% interest (compounded daily and credited monthly). With the standard program, just doing quick math, my return would have been $200.40 on the $50,000 savings account for 1 year. The positive is that it would be risk free since it has FDIC insurance (up to $250,000 per account) and you can get the money quickly - it is only an ATM machine away. The negative is that it is not keeping up with inflation and you'd be losing ‘real’ money every day (investment return is less than inflation). Fullstacks sent me the following URL that gives the highest paying interest rates in the US for checking accounts (there are a number of restrictions on these accounts and you need to read the full details): https://www.checkingfinder.com/search/95008. There are some that have interest rates over 3%.
• Money market funds: Before the financial crisis of 2008 and the Lehman Brothers bankruptcy, money markets always paid back your principal. For every share, the net asset value was $1. With the Lehman Brothers bankruptcy a few money market funds had net asset values under $1 (it was called ‘breaking the buck’ for individual investors). There would have been more money market funds ‘breaking the buck’ but at least 20 companies spent billions to prop up their funds (the US Treasury started to guarantee the $1 net value in September 2008 and it only lasted 1 year. The Treasury did not want a run on money market funds like the run on the savings banks during the Great Depression.). The goal of money market funds is to invest in only high-quality (by today's standards) short-term securities to maintain the net asset value of $1. I checked the Vanguard website and their Vanguard Prime Money Market Fund (VMMXX) is paying .13% (the 5 year average was 3.01%). This fund has outperformed the money markets funds benchmark average over the last 5 years. If I invested my $50,000, my total return would be around $65 (ouch! - I remember when money markets were paying 15% in the early 1980s). The positive is that it is relativity low risk (unless we have another financial crisis) and with most money market funds you can write checks to get your money. The negative is that it is not keeping up with inflation and you would be losing ‘real’ money every day. And the net asset value could go lower than $1 if we have another financial meltdown (the US Treasury stopped the $1 net value guarantee after September 18, 2009).
• Certificates of Deposit (CD): The highest 3 and 6 month CD coupon rate that I could find was .2% on the 3 and 6 month CDs on the Fidelity and Schwab websites. If I use a CD ladder using 3 and 6 month CDs my total return for the year would be around $102 for my $50,000 investment. The positives are that it would be risk free since it has FDIC insurance (up to $250,000 per account) and that the interest rate is guaranteed for the maturity of the CD. Again, the negative is that it is not keeping up with inflation, you would be losing ‘real’ money every day and if you needed the money before 1 of the CDs matures, you'll pay a penalty (using CD laddering you would always have some cash available).
• Treasury Bills (TBs) - maturity up to 52 weeks: Checking the US Treasury website, the 13 week treasury interest rate is .15% and the 26 week rate is 19%. If I ladder the 13 and 26 week TBs, the return on my $50,000 investment would be around $70 for the year. The positive is that US Treasuries are backed by the printing press of the US Treasury (as long as they can buy paper and ink they are guaranteed). And they could be sold on a secondary market. TBs carry the lowest risk of losing your money. The negative is that it is not keeping up with inflation and you are losing ‘real’ money every day.
• I-Bonds / Treasury Inflation Protected Securities (TIPS): Maturity for I-Bonds and TIPS is 5 years or greater so they will not work for my emergency cash management strategy. I-Bonds and TIPS have penalties if you do not hold them to maturity.
• Short Duration Bond Exchange Traded Funds (ETFs): Two examples of short duration bond ETFs are the following: Vanguard Short Term Bond Fund (BSV), the1 year return on which was 5.06% and average duration was 2.6 years and iShares Barclays 1-3 Year Credit Fund (CSJ) the 1 year return on which was 6.15% and the average duration was 1.94 years. The positives are that you get much higher yields than savings accounts, money market funds, CDs and TBs, your cash investment will keep up with or exceed the inflation rate, you can sell your investment at any time (just like stocks) and if interest rates go down your investment will increase. The negative is if interest rates go up your investment will decrease (the shorter the duration, the less your investment will decrease). If you are interested in bond duration and interest rates effects on bond funds, read the following blog: http://paulsgang.blogspot.com/2010/02/bonds.html. Using CSJ as an example, if interest rates go up by 1% your investment would decrease by 1.94% (CSJ duration X interest rate increase); it has the opposite effect if interest rates go down.
• ‘High Quality’ Dividend Paying ETFs: Two examples of ETFs that pay dividends you could use in your cash management strategy are: SPDR S&P Index (SPY) which currently yields 2.03% (the index of the S&P 500 companies) and iShares Dow Jones Select Dividend Index (DVY) which currently yields 3.89%. The positives are: you get much higher yields than savings accounts, money market funds, CDs and TBs; your cash investment will keep up or exceed the inflation rate; you can sell your investment at any time (just like stocks); and if the stock price of the ETF increases your investment will also increase. The negative is that dividends are not guaranteed (companies can stop or decrease their dividends at any time) and the ETF stock could decrease which would decrease your investment.
You cannot use your ‘Dad’s’ or pre-financial crisis (pre-2008) cash management strategy to make a fair return on your emergency cash fund with relativity low risk. You can no longer just put your emergency cash fund in a savings account and short term CDs. The interest rate for a 26 week TB was over 5% in 2007 (.19% today), savings account interest rate was over 5% in 2007 (around .2% today), 6 month CD interest rate was over 5.5% in 2007 (now .2%) and money market funds were over 15% in the early 1980s (today around .13%). You are going to have to diversify your emergency cash fund investments. The following is one sample cash management strategy: savings account $17,000, short duration bond ETF $17,000 and ‘high quality’ dividend paying ETF $16,000 (total $50,000).
• B of A Growth Cash Maximizer program - interest rate .20%: $34
• iShares Barclays 1-3 Year Credit Fund - return 6.15%: $1045.50
• iShares Dow Jones Select Dividend Index - yield 3.89% $622.40
The total 1 year return was $1701.90 with a 3.4% yield. The yields from the examples are much better than you are going to get from savings accounts, money market funds, CDs , and treasury bills alone. For protection with the short duration bond and ‘high quality’ dividend-paying ETFs, you could use trailing-stop orders to protect yourself from losing a percent of your cash investment.
Please chime in with comments about my cash management strategy for 2010. What is your strategy to get a ‘fair’ return with low risk? If you have any ideas about future blogs please add a comment.
© 2010 Paul Cusick
Paul
Saturday, August 21, 2010
Friday, August 13, 2010
Investment Update #1 (August 13, 2010)
I will be updating my blog when I make investment decisions. For example, buying or selling stocks or ETFs, changing my investment allocation, change of investment strategy, etc. This is the first of my investment update blogs:
I brought 500 shares of the Pro Shares UltraShort (PST) Exchange Traded Fund (ETF) Monday August 12, 2010 at $40.84 in my non-taxable account (from prospectus: Seeks daily investment results, before fees and expenses and interest income earned on cash and financial instruments, that correspond to twice (200%) the inverse (opposite) of the daily performance of the Barclays Capital 7-10 Year U.S. Treasury Index.). US treasury yield curve for August 11 was 2.08% for seven year and 2.72% for ten. For August 12, 2010 the treasury daily yield curve was 2.11% for seven year and 2.74% for ten year. For more information on PST and shorting US treasuries please read the following blog: http://paulsgang.blogspot.com/2010/01/this-blog-i-would-like-to-talk-about.html.
Please chime in with comments on what you think of shorting US treasuries and my PST ETF investment.
© 2010 Paul Cusick
Paul
I brought 500 shares of the Pro Shares UltraShort (PST) Exchange Traded Fund (ETF) Monday August 12, 2010 at $40.84 in my non-taxable account (from prospectus: Seeks daily investment results, before fees and expenses and interest income earned on cash and financial instruments, that correspond to twice (200%) the inverse (opposite) of the daily performance of the Barclays Capital 7-10 Year U.S. Treasury Index.). US treasury yield curve for August 11 was 2.08% for seven year and 2.72% for ten. For August 12, 2010 the treasury daily yield curve was 2.11% for seven year and 2.74% for ten year. For more information on PST and shorting US treasuries please read the following blog: http://paulsgang.blogspot.com/2010/01/this-blog-i-would-like-to-talk-about.html.
Please chime in with comments on what you think of shorting US treasuries and my PST ETF investment.
© 2010 Paul Cusick
Paul
Monday, August 9, 2010
Tradable REITs Investing – Office Buildings
In this blog, I explore investing in tradable (listed on a stock exchange) REITs of the ‘office building’ type. For my investigation, I used the largest (based on market capitalization of $11.85 billion) office building REIT company, Boston Properties Inc. (BXP). There is a great deal of very good investment information available in the annual report and 10K form (included in the annual report). URL for Annual Report and 10K form:
http://ir.bostonproperties.com/phoenix.zhtml?c=120176&p=irol-reports.
Several macro/micro economic and business factors are important in the overall return on investment (share price gain + dividend return) and the pricing of BXP’s major asset i.e. office buildings.
Macro/micro economic factors:
· Employment rate – One of the major economic risk factors for office building REITs is a high unemployment rate. Increasing unemployment will decrease the overall demand for office space which drives down the cost of office space (and decreases the profits of the REIT). This leads to decreased dividend payout by the REIT. BXP dividends decreased from $8.70 (9.48%) in 2007 to $2 (3.44%) in 2009 (the dividend payout has been $.50 per quarter in 2010).
· Deflation/Inflation – One of the best investments for inflation or hyper-inflation is ‘real assets’. Office buildings are ‘real assets’. Inflation or hyper-inflation will drive up the values of office buildings and increase the cost of office space. This will lead to increased share prices and dividend payouts. It has the opposite effect with deflation – lower value of office buildings and lower dividend payout which leads to lower stock prices.
· Economic direction – This is another major economic risk factor for office REITs (as well as other REITs). When the recession started in 2008 it had a major effect on BXP (and other REITs). When two of their ‘quality’ tenants filed for bankruptcy, it became much more difficult to fund expansion and make mortgage balloon payments, which decreased the value of their office buildings, etc. This had the effect of dropping their stock price from a high of $127.04 in April 2007 to a low of $31.73 in February 2009 (it is currently around $80).
Business factors:
· Debt servicing/capital sources – The majority of commercial (office building) mortgages require the borrower to simply make a mortgage payment small enough to pay off the mortgage in 30 years and then make a balloon payment in 7 or 10 years. The owner can either sell or refinance the property when the balloon payment is due. The 10K form shows all mortgage debt by office building and includes the balloon payment date. It also shows the mortgage balloon payments due by year. After reviewing BXP’s mortgage debt most of it is proportionally the same per year over the next 7 years except for 2011when it is double that of 2010. You would not want to see that most of its balloon payments are due in the same year. This could raise the cost of debt financing. BXP has done a very good job of either refinancing or selling property in the last 2 years in a very difficult capital market. The liquidity crisis resulting from the subprime lending crisis could be a major risk to office building REITs. Since REITs must return at least 90% of their earning to shareholders, they cannot finance expansion by retaining earnings – they must borrow money to expand.
· Lease rate and lease expiration date – The 10k form will list the lease rate of the building and lease expiration date by percent per year. For example, 9.1% of the leases will expire in 2010, 8.1% will expire in 2011, etc. When you are researching REITs you do not want to see a large percent of leases expiring in one year or near term. BXP has done a very good managing their lease expiration dates.
· Tenants rating – It’s very important that tenants are of the highest quality. Business bankruptcy has a very negative effect on the earnings of REITs. BXP had two major tenant bankruptcies that terminated their leases, Lehman Brothers and General Motors (it is sometimes hard to identify high quality tenants). This caused two major problems: they lost over one year of rent and in a declining economy they needed to drop the price of office space to be able to lease the buildings. The 10K form will list the major tenants so you can assess whether they are of the highest quality (unlikely to go bankrupt) or have not paid their lease (or need to decrease their payments to stay in business).
· Tenants business sector– It is very important that REITs have tenants that are in diverse business sectors. All tenants should not be in the same business sector, for example, financial services. In the event there is a major decline in financial services, it could have a major effect on the REIT earnings. The tenants’ business sectors are listed in the 10k form. BXP’s largest business sectors are legal services (26%), financial services (24%), and manufacturing/consumer products (10%).
· Regional diversification – BXP are located in the following areas: Boston, Washington D.C., mid Manhattan (New York City), San Francisco and Princeton, New Jersey. It is important that the office buildings are located in more than one geographical area. If all its office buildings were located in one area, it could be disproportionately affected by local economic factors. The 10k form will list every office building by location and square feet of available office space.
· Management – Key to the success of any business is the strength of its management. For REITs it is especially important that management are able to choose optimal office locations (and when to sell the assets), attract high quality tenants, and acquire new sources of funding for building new buildings and re-financing their existing buildings (balloon payments every 7 to 10 years) at low cost. It speaks to the strength of BXP’s highly experienced management team that BPX holds prime office space locations in the US, has high quality of tenants and has been able to raise capital at a reasonable rate (in a very difficult economic environment) for making balloon mortgage payments (to avoid being forced to sell the property) and funding future expansion.
· Earnings – The best measurement for reviewing office building REITs’ earnings is Funds From Operations (FFO). This has become the REIT industry standard for evaluating overall performance of REITs. It excludes the historical depreciation cost from the net income amount. It is also interesting to review the REIT dividend payout ratio as a measure of its sustainability for paying out future dividends. This information is included in the 10K form.
All REITs are particularly sensitive to changes in the economy. When the macro and micro economic factors that are favorable to BXP change, I will invest in BXP. It has offices in all the prime office location areas in the US, a strong management team and probability of a high dividend payout in the future. For now, I will keep BXP as an arrow in my quiver waiting for the right economic environment.
Please chime in with comments about Boston Properties Inc., buying tradable REITs, economic forecast for types of REITs (office building, retail, medical, etc.), REITs to buy or short, etc. Next blog I’ll write about cash management in this difficult economic environment and whether ‘high quality’ dividend paying companies are a good idea for cash investment.
© 2010 Paul Cusick
Paul
http://ir.bostonproperties.com/phoenix.zhtml?c=120176&p=irol-reports.
Several macro/micro economic and business factors are important in the overall return on investment (share price gain + dividend return) and the pricing of BXP’s major asset i.e. office buildings.
Macro/micro economic factors:
· Employment rate – One of the major economic risk factors for office building REITs is a high unemployment rate. Increasing unemployment will decrease the overall demand for office space which drives down the cost of office space (and decreases the profits of the REIT). This leads to decreased dividend payout by the REIT. BXP dividends decreased from $8.70 (9.48%) in 2007 to $2 (3.44%) in 2009 (the dividend payout has been $.50 per quarter in 2010).
· Deflation/Inflation – One of the best investments for inflation or hyper-inflation is ‘real assets’. Office buildings are ‘real assets’. Inflation or hyper-inflation will drive up the values of office buildings and increase the cost of office space. This will lead to increased share prices and dividend payouts. It has the opposite effect with deflation – lower value of office buildings and lower dividend payout which leads to lower stock prices.
· Economic direction – This is another major economic risk factor for office REITs (as well as other REITs). When the recession started in 2008 it had a major effect on BXP (and other REITs). When two of their ‘quality’ tenants filed for bankruptcy, it became much more difficult to fund expansion and make mortgage balloon payments, which decreased the value of their office buildings, etc. This had the effect of dropping their stock price from a high of $127.04 in April 2007 to a low of $31.73 in February 2009 (it is currently around $80).
Business factors:
· Debt servicing/capital sources – The majority of commercial (office building) mortgages require the borrower to simply make a mortgage payment small enough to pay off the mortgage in 30 years and then make a balloon payment in 7 or 10 years. The owner can either sell or refinance the property when the balloon payment is due. The 10K form shows all mortgage debt by office building and includes the balloon payment date. It also shows the mortgage balloon payments due by year. After reviewing BXP’s mortgage debt most of it is proportionally the same per year over the next 7 years except for 2011when it is double that of 2010. You would not want to see that most of its balloon payments are due in the same year. This could raise the cost of debt financing. BXP has done a very good job of either refinancing or selling property in the last 2 years in a very difficult capital market. The liquidity crisis resulting from the subprime lending crisis could be a major risk to office building REITs. Since REITs must return at least 90% of their earning to shareholders, they cannot finance expansion by retaining earnings – they must borrow money to expand.
· Lease rate and lease expiration date – The 10k form will list the lease rate of the building and lease expiration date by percent per year. For example, 9.1% of the leases will expire in 2010, 8.1% will expire in 2011, etc. When you are researching REITs you do not want to see a large percent of leases expiring in one year or near term. BXP has done a very good managing their lease expiration dates.
· Tenants rating – It’s very important that tenants are of the highest quality. Business bankruptcy has a very negative effect on the earnings of REITs. BXP had two major tenant bankruptcies that terminated their leases, Lehman Brothers and General Motors (it is sometimes hard to identify high quality tenants). This caused two major problems: they lost over one year of rent and in a declining economy they needed to drop the price of office space to be able to lease the buildings. The 10K form will list the major tenants so you can assess whether they are of the highest quality (unlikely to go bankrupt) or have not paid their lease (or need to decrease their payments to stay in business).
· Tenants business sector– It is very important that REITs have tenants that are in diverse business sectors. All tenants should not be in the same business sector, for example, financial services. In the event there is a major decline in financial services, it could have a major effect on the REIT earnings. The tenants’ business sectors are listed in the 10k form. BXP’s largest business sectors are legal services (26%), financial services (24%), and manufacturing/consumer products (10%).
· Regional diversification – BXP are located in the following areas: Boston, Washington D.C., mid Manhattan (New York City), San Francisco and Princeton, New Jersey. It is important that the office buildings are located in more than one geographical area. If all its office buildings were located in one area, it could be disproportionately affected by local economic factors. The 10k form will list every office building by location and square feet of available office space.
· Management – Key to the success of any business is the strength of its management. For REITs it is especially important that management are able to choose optimal office locations (and when to sell the assets), attract high quality tenants, and acquire new sources of funding for building new buildings and re-financing their existing buildings (balloon payments every 7 to 10 years) at low cost. It speaks to the strength of BXP’s highly experienced management team that BPX holds prime office space locations in the US, has high quality of tenants and has been able to raise capital at a reasonable rate (in a very difficult economic environment) for making balloon mortgage payments (to avoid being forced to sell the property) and funding future expansion.
· Earnings – The best measurement for reviewing office building REITs’ earnings is Funds From Operations (FFO). This has become the REIT industry standard for evaluating overall performance of REITs. It excludes the historical depreciation cost from the net income amount. It is also interesting to review the REIT dividend payout ratio as a measure of its sustainability for paying out future dividends. This information is included in the 10K form.
All REITs are particularly sensitive to changes in the economy. When the macro and micro economic factors that are favorable to BXP change, I will invest in BXP. It has offices in all the prime office location areas in the US, a strong management team and probability of a high dividend payout in the future. For now, I will keep BXP as an arrow in my quiver waiting for the right economic environment.
Please chime in with comments about Boston Properties Inc., buying tradable REITs, economic forecast for types of REITs (office building, retail, medical, etc.), REITs to buy or short, etc. Next blog I’ll write about cash management in this difficult economic environment and whether ‘high quality’ dividend paying companies are a good idea for cash investment.
© 2010 Paul Cusick
Paul
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