Art. 24 · Reserves and return · 4 min read
Insurance-grade investment
Reserve money has a second specification besides return, and it is usually left blank: how far the value can move between now and the day you need it.
Two funds both average 6% a year. One moves by roughly 5% in a typical year; the other by roughly 20%. For a long-term growth pot, the second may well be the better choice. For a risk reserve it is close to unusable, and the reason is specific.
The moment you need a reserve is not random. Fires and floods are, but many of the things that drain a reserve arrive alongside bad conditions everywhere else: a customer failing, a downturn in trade, a legal dispute, a funding round falling through. That is exactly when a volatile holding is down. You end up selling at the bottom to fund a loss, and the drawdown becomes permanent.
- Low-volatility holding: a dull, steady climb
- High-volatility holding: same destination, a very different ride
This is why investment-grade corporate bond funds come up so often in this conversation. They sit in a middle band, with more return than cash and far smaller swings than equities, and they are deep and liquid enough to sell without moving the price. The large US-listed investment-grade corporate bond ETFs, of which LQD is the most cited example, are the usual illustration of the category. That is a description of a category, not a recommendation of a holding: currency, credit risk and interest-rate sensitivity all still apply, and 2022 was a reminder that "low volatility" does not mean "no bad years."
One practical structure that sidesteps most of this: split the reserve. Keep the first layer, enough for the excesses and immediate cash needs after a loss, in instant-access cash, accepting that it will lose a little to inflation. Put the deeper layer, the part that would only be called on in a serious year, somewhere with a modest return and small swings. The first layer buys speed; the second buys purchasing power.
Use it
- Write down the specification before choosing a home. How much, available how fast, and what fall in value would be intolerable.
- Ask for the volatility number, not just the return. Any fund factsheet has it. If the person selling it only quotes return, that is informative.
- Layer the reserve. Instant-access cash for the first slice, low-volatility holdings for the deeper slice.
- Take advice for anything material. This article explains a trade-off; it does not tell you what to buy, and anyone managing a substantial reserve should be talking to a regulated adviser.