After determining a reserve policy and segmenting assets, the short-term reserve investments will need to mitigate risk.
Organizations looking to make the best use of short-term assets can mitigate risk in three different ways:
- Using FDIC insured products or accounts (CDs and bank money market or savings accounts)
- Buying bonds backed by the U.S. Treasury or other U.S. government agencies
- Having diversified funds that invest in high quality government or corporate bonds (fixed income mutual funds)
If the timing is clear that cash will be spent several years out, it’s highly efficient to use individual CDs or government bonds that mature near when the funds are needed. If there is no specific timing for withdrawals, we recommend using low-cost bond mutual funds that will exist in perpetuity. We suggest targeting a certain short-term average maturity that’s in line with the potential timing of withdrawals. The average credit quality should be very high (AA or higher) so it’s less likely that the portfolio would be down notably when funds are needed for withdrawal. As the time frame expands beyond two or three years, having a small allocation (10 – 20%) to equity could provide additional diversification for the portfolio.
Given that the purpose of the reserve is to cover a future cash outflow, we recommend that these investments be very liquid so that they can be quickly exited when it becomes necessary to make an outlay.