Investment strategy refers to the guidelines used when selecting investments. A number of possible investment strategies are noted in the following bullet points, which incorporate varying levels of risk tolerance. When considering the options, please note that the more active ones require accurate cash forecasts, which may not be available.
- Earnings credit. The simplest investment option of all is to do nothing. Cash balances are left in the various bank accounts, where they accrue an earnings credit that is offset against the fees charged by the bank for use of the accounts. If cash balances are low, this can be an entirely acceptable strategy, since more active management of a small amount of cash will probably not glean a significantly larger return.
- Automated sweeps. Sweep all excess cash into a central account, and shift the funds in that account to an overnight investment account. This strategy requires no staff time, but yields a low return on investment, since banks charge significant fees to manage this process.
- Laddering. The laddering strategy involves making investments of staggered duration, so that the company can take advantage of the higher interest rates typically associated with somewhat longer-term investments. For example, a treasury department can reasonably forecast three months into the future, so it invests in a rolling set of investments that mature in three months. To begin this strategy, it invests a block of funds in an investment having a one-month maturity, another block in an investment with a two-month maturity, and yet another block in an investment with a three-month maturity. As each of the shorter investments matures, they are rolled into new investments having three-month maturities. The result is an ongoing series of investments where a portion of the cash is made available for operational use at one-month intervals, while taking advantage of the higher yields on three-month investments.
- Match maturities. An option requiring manual tracking is to match the maturities of investments to when the cash will be needed for operational purposes. This method calls for a highly accurate cash forecast, both in terms of the amounts and timing of cash flows. To be safe, maturities can be planned for several days prior to a forecasted cash need, though this reduces the return on investment.
- Tiered investments. If a business has more cash than it needs for ongoing operational requirements, the treasury staff can conduct an analysis to determine how much cash is never or rarely required for operations, and use this cash in a more aggressive investment strategy. The tiered investment strategy requires close attention to the cash forecast, particularly in regard to the timing and amount of the occasional cash usage items. Otherwise, there is a risk of being caught with too much cash in an illiquid investment when there is an immediate need for the cash.
- Ride the yield curve. An active treasury staff can buy investments that have higher interest rates and longer maturity dates, and then sell these investments when the cash is needed for operational purposes. Thus, a company is deliberately buying investments that it knows it cannot hold until their maturity dates. If the yield curve is inverted (that is, interest rates are lower on longer-maturity investments), you would instead continually re-invest in very short-term instruments, no matter how far in the future the cash is actually needed again by the company.
A variation on all of the preceding strategies is to outsource the investment task to an experienced third party money manager. This option works well if a company is too small or has too few cash reserves to actively manage its own cash. If outsourcing is chosen, be sure to set up guidelines with the money manager for exactly how cash is to be invested, primarily through the use of lower-risk investments that mitigate the possibility of losing cash. A variation on the outsourcing concept is to invest primarily in money market funds, which are professionally managed.