Managing your investment program in today's market.

• Author: Larson, M. Corinne
• Position: Money Management Matters - Brief Article

Interest earnings from investments often are an important revenue source for governments. In today's markets, historically low interest rates make this especially difficult. Investors of public funds may be tempted to chase yield by extending maturities too far into the future or by purchasing exotic securities. However, these investment tactics add volatility to the government's portfolio and should be avoided.

Since history tends to repeat itself, investors would do well to remember the highly publicized investment losses of 1994. From California to Maine, public entities lost millions of dollars when the market value of their investments fell because of rising interest rates. How did this happen? The early 1990s brought low interest rates, prompting investors to purchase securities with high market volatility to increase their investment earnings. With higher returns, however, comes higher risk. Investors learned this lesson the hard way when they needed to sell investments prior to maturity and found that they either could not find a buyer for their securities or they had to sell the securities below the principal amount. Investors who held their investments to maturity discovered the market value of their portfolios was significantly less than the historical cost.

To make the most effective use of idle funds, public investors must try to earn the best returns possible without sacrificing the safety of their funds or subjecting their portfolios to undue risks. Investors must achieve this goal within the constraints of applicable laws, investment policies, and other internal practices. In addition, investors must make their decisions within the overriding principles of safety, liquidity, and yield. Investors who follow these principles can avoid being tomorrow's headlines.

Making Investment Decisions

Investing is a complicated process. Although a formal investment policy identifies investment objectives, defines risk tolerance, assigns responsibility for the investment function, and establishes control over the investment process, it does not tell the investor what investment instruments to purchase, how much to invest, or how long to invest. Public investors typically make investment decisions based on cash flow needs. In many cases, idle funds are deposited in interest-bearing accounts or invested in short-term liquid investments until the funds are needed. When large amounts of cash will be available for a set period of time, the...