Investing: Time to Stay Liquid

The investment world has turned upside down in recent months: the housing market and economy are slowing, stocks have been sinking, bond yields may be peaking, and after 17 consecutive rate hikes, the Federal Reserve seems all but done. Should your strategy be flipped as well? This is no time to sit on your thumbs, sticking with the same old industrial and commodity stocks that have done so well for so long but have slumped recently. You may also be overexposed to the stock of small companies, which until a few months ago had been scorching hot. Bonds have been a poor bet for a while.

Conversely, short-term cash instruments haven't looked this good in years. Simple, safe money-market funds now yield a healthy 5%--not bad in an uncertain environment in which Treasury bonds yield just a tad more and corporate profits are likely to downshift from double-digit growth to the 6%-to-8% range. For the past few months, money funds have had the best returns of the major asset classes. It used to be tough to find much more than a 1% money-fund yield."Having liquidity and getting 5% are a big deal," says Peter Crane, president of money-fund tracker Crane Data.

For the first time in years, it pays to pay attention. You may be stuck earning a token amount in a forgotten bank savings account or brokerage sweep account. If so, make a change. Bank CDs have O.K. yields. But with a CD, you lock up your money at a fixed rate of return for a period of months. Money funds have similar rates of return without locking up your cash, and with a money fund, you are certain to get higher rates if the Fed persists in boosting its benchmark federal funds rate.

"I'd be very happy sitting on the beach earning 5% and just not worrying for a few months," says Tony Proctor, president of money-management firm Proctor Financial. He is raising the money-fund portion of all five of his model portfolios, citing worries over rising oil prices, a slowing economy, the summer stock-market doldrums and soaring tensions in the Middle East.

Cash may be king right now, but don't overdo it. If you normally keep 10% of your portfolio in cash, consider going to 15%. Cash rarely returns more than stocks and bonds do over the long run.

Ned Notzon, chairman of the asset-allocation committee at fund company T. Rowe Price, loves cash for the next few months and, he concedes, "We're not in love with the stock market." Yet he's holding minimal cash and boosting his exposure to stocks. Why? He's thinking long term, and after a slide, stocks have become more attractive. When it's clear the Fed is finally done boosting rates (which it may be even now), the market could rally.

Remember, though, that "a lot of the stocks that investors had been aggressively buying are going to be tough places to be for a while," warns Stuart Freeman, chief equity strategist at brokerage A.G. Edwards. He's leaning away from the stocks of small companies, which tend to do best early in a recovery and have had a long run of superior returns. He's also underplaying boom-bust industrial and commodity stocks in favor of blue-chip steady growers like health-care (Lilly) and consumer products (Pepsico, Procter & Gamble).