Investing: More than Just Safety, Liquidity, and Yield

From school districts to cities and towns, whatever your local government may be, you may have a mission and a plan based on a set of values that are shared by your community. When it comes to investing your local government’s money, as a shepherd of your taxpayers’ dollars, it is your fiduciary responsibility to prioritize keeping those funds safe while striving to earn a competitive rate of return.

We at Michigan CLASS believe that the primary objectives of investing public funds are safety, liquidity, and yield (in that order). We also think that transparency and diversification should be considered. Let’s walk through each of these features of investing.

Safety: The Importance of Getting Your Principal Back.

When investing, you are buying creditworthiness. In the case of buying a U.S. Treasury, you are relying on the ability of the U.S. Government to repay its debt. When buying commercial paper, you are relying on the ability of a bank or corporation to repay its debt. U.S. Treasuries are referred to as “risk-free assets” meaning that there is no implied risk that the U.S. Government will not repay its debt. That said, every investment you buy carries some degree of risk. Credit ratings can serve as a guideline for risk but should not be used as the sole source of information when making investment decisions.

Liquidity: How Quickly Can I Sell my Investment and Turn it into Cash?

A simple example would be fine art. Let’s say you own the Mona Lisa. There is no doubt it is worth a lot and could be a fine investment. But how quickly can you find a buyer for the painting and convert that value to cash? Potentially not very quickly. Conversely, cash-like investments such as local government investment pools (LGIP) are considered highly liquid investments in which you can convert your investment into cash within a day. Always make sure you have adequate liquidity to cover your specific cash flow needs.

Yield: What am I Earning on my Investment?

The yield component is a heavily referenced aspect of investing. If we were not concerned about yield, we would just keep our funds in a savings account. The potential pitfall is when an investor focuses primarily on yield while ignoring the safety and liquidity components of investing. Focusing primarily on yield could be detrimental to the overall strategy of limiting risk and satisfying liquidity requirements.

Transparency: Do You Understand and Have Access to Information About Your Investments?

There are several ways to look at transparency when it comes to investments. First, are your investments transparent to you? Make sure you know what you are investing in. If you are using an LGIP, you should be able to see the underlying assets in that pool. Another way to look at transparency is from the taxpayer side. Are you being transparent with the investments made on behalf of your entity? Periodic investment reports can be a great tool to aid in transparency with the public.

Diversification: Are all Your Eggs in One Basket?

You’ve heard the saying “don’t put all your eggs in one basket.” Well, the same can be said when investing public funds. This is especially true when considering riskier asset classes. If you are an entity that is buying corporate bonds, well-diversified assets can help to minimize investment risk.

When considering the components of public funds investing, it can be beneficial to  understand what you are investing in. A  careful consideration of each of the five factors and how they impact your local government can aid in this goal. Feel free to contact your local Michigan CLASS representative with any questions.

Many factors affect performance including changes in market conditions and interest rates and in response to other economic, political, or financial developments. Investment involves risk including the possible loss of principal. No assurance can be given that the performance objectives of a given strategy will be achieved. All comments and discussions presented are purely based on opinion and assumptions, not fact. These assumptions may or may not be correct based on foreseen and unforeseen events. The information presented should not be used in making any investment decisions. This material is not a recommendation to buy, sell, implement, or change any securities or investment strategy, function, or process. Any financial and/or investment decision should be made only after considerable research, consideration, and involvement with an experienced professional engaged for the specific purpose. Michigan CLASS is not a bank. An investment in Michigan CLASS is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the Michigan CLASS prime-style fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. Past performance is not an indication of future performance. Any financial and/or investment decision may incur losses.