Can you blame your clients for wanting to take their money out of virtually no-yield money market funds?

Perhaps you can't blame them. But with good advice, you can help them fight a war that the Federal Reserve has declared on cash. Whether or not ZIRP began as a war on cash, it has become one as the Fed persists in holding rates at rock-bottom month after month. Whatever benefit ZIRP may have in stimulating a recovery short-term, it is punishing savers, distorting financial markets, and skewing asset allocation strategies toward risk-taking that many investors may regret, long-term.

Now is the time to remind your clients, especially retirees and pre-retirees, of the valuable role cash plays in sound planning and portfolio management. You also can reinforce the fact that cash has unique properties for protecting against the uncertainties, distortions, bubbles and blow-ups that ZIRP is breeding.

In this article, I'll offer ammunition and ideas to help you.

Why ZIRP Is a War on Cash

Cash, the bedrock level of U.S. savings, consists of $8.9 trillion in savings, small time deposits (CDs) and money market mutual funds. America's cash holdings have more than quadrupled over the past quarter century. As a percent of real GDP, cash increased from 28% in 1985 to 72% by 2009. This was a positive trend for the U.S. economy because cash is the fuel of future growth including personal consumption, home-buying and investing.

Only once before in the last 25 years has America's cash holdings declined – by about $85 billion in the recession of 1991-92. Since the ZIRP era began 18 month ago, our nation's cash has dropped by $430 billion. Cash as a percentage of real GDP has declined from 72% to 67%.

If you assume the Fed is holding interest rates 2% below where they would normally be, without interference, the annual interest income lost to households and businesses amounts to about $180 billion. Of course, the cost falls heavily on retirees who have saved diligently for decades. But there are other victims, too.

For example, the average management fee that U.S. mutual funds earn on money market assets is 34 basis points, according to the ICI. So, the loss of over $1 trillion in money market assets under ZIRP is costing the mutual fund industry more than $3 billion in annual revenue. For a privately-held company with $10 million in cash-on-hand, ZIRP might be costing enough interest income to fund the salaries and benefits of three or four full-time employees.

The Fed's commitment to ZIRP is clear in its pledge to keep rates "exceptionally low" for an "extended period." Only one voting member of the Federal Open Market Committee (FOMC), Thomas M. Hoenig, has dissented from this policy. For three straight FOMC meetings, he has warned that ZIRP will lead to future imbalances and increase risks to long-term economic growth and financial stability. As Hoenig emphasized in a recent speech called What About Zero: "Thanks to the combination of near-zero short-term interest rates and the Federal Reserve's large-scale purchases of mortgage-backed securities, investors are flush with cash. And, as is sometimes the case, cash earning so little is an enticement to take on additional risk in hopes of higher returns."

You can read the text of his entire speech, delivered April 7, here: http://www.kansascityfed.org/speechbio/hoenigpdf/hoenig.santafe.04.07.10.pdf

Here are several specific imbalances, distortions and pressures ZIRP is creating:

• The flight to bonds – ZIRP is forcing prudent savers to move assets from cash into bonds in search of higher yields. In 2009 and YTD 2010, for example, about $630 billion of net cash has flowed into U.S. bond mutual funds. This is happening at a phase in the interest rate cycle when bond investors are most vulnerable to rising rates and bond price declines. As the credibility of bond insurance and ratings companies has been shredded, bond investors also are more vulnerable to disappointments, downgrades and defaults. It is becoming clear that one of the Fed's unstated goals in ZIRP is to chase money out of cash into bonds, to prop up an increasingly fragile bond market.

• Cash substitutes – As assets floods out of cash, institutions and traders are finding new high-yield places to stash cash, at least for now. One place you can see this impact is in the U.S. equity REIT market. Since ZIRP began, a leading index of U.S. commercial real estate properties, the Moody's/REAL CPPI, has declined by about 35%. Over the same period, the leading index of equity REITs, the Dow Jones U.S. Real Estate Index, has increased by more than 50%.

These two indexes measure the same underlying trend – the value of high-grade U.S. commercial real estate (CRE) properties. The difference is that REITs are exchange-traded and liquid, while physical CRE properties are not. The liquidity and high yields of REITs have turned them into "cash substitutes" for institutions and traders, some of whom are using leverage to boost yield. Even if REIT prices start to crash, traders are confident they can cut losses quickly via stop-loss orders or hedges.

But can they? The whole U.S. equity REIT market has only $250 billion in market capitalization, according to NAREIT – about the same as Apple or Microsoft. So, ZIRP has helped to turn what was a stable long-term asset class into a short-term leveraged casino. It has distorted the U.S. REIT market and made it toxic for prudent investors, perhaps for years to come.

Five Key "Cash Reminders" to Offer Your Clients

1. Cash is the bedrock – Even before asset allocation strategies became popular in the 1990s, cash was the bedrock asset class for building financial security. Financial planning courses taught that each household should maintain 3-6 months of average spending in cash, at minimum, to be prepared for hard times or emergencies. With an all-time record 15 million Americans now officially unemployed, cash is more important than ever.

2. Cash is a balancer and risk-reducer – The cash component of asset allocation strategies acts as a counterweight to the risk of stocks. In the two stock market crashes of the last decade, many investors who had allocated even 20-25% of a portfolio to cash were able to hold on through the deepest part of declines.

3. The timing is wrong – In the modern era, the Fed loosens or tightens monetary policy in incremental moves spread over many months, or even years. The table below summarizes three recent Fed loosening/tightening cycles.

Three Recent Fed Rate Action Cycles

If investors want to move money from cash to bonds in search of higher yields, the move should be made during a Fed loosening cycle, preferably in the early moves. For example, around November of 2007 would have been good timing, because the Fed had just announced its third loosening move (of what would become 12), and the outlook was for more rate cuts to follow. Bonds benefit from rate cuts because lower yields increase bond prices.

The Fed can't easily cut interest rates lower than ZIRP (without extraordinary measures) so there is no upside left for bond investors. This is the worst time imaginable to move money from cash into bonds.

Three Ideas to Help Your Clients Cope

When clients ask how they should cope with large amounts of savings in cash, earning almost nothing, what can you say in response? Here are three ideas:

Idea #1 – Talk about the 1960s: The last time short-term interest rates were nearly this low was the early 1960s, when one-year Treasury bills were below 3% and 10-year Treasuries were below 4%. Over the next two decades, interest rates increased steadily, peaking at almost 14% in the early 80s. So, who was able to adjust to rising rates and earn higher returns during that era?

Cash proved much more resilient and reliable than bonds. Cash holders had the opportunity to increase yields (and keep pace with rising inflation) in 15 of 20 years between 1960 and 1980. Cash holders also could have chosen to "lengthen maturities" and gradually and lock in higher rates as the interest rate cycle progressed. Bond investors were punished by constantly falling prices during this era. They had limited flexibility to participate in higher rates, without taking heavy losses on prices, and basically wasted two decades earning very low or negative returns.

Idea #2 – Reverse dollar cost averaging: What advice can you give clients who have already responded to ZIRP by jumping from cash into bonds? Encourage them to "reverse dollar cost average" by gradually liquidating bonds and moving into cash. For bond mutual funds, you can set up systematic withdrawal plans to make a series of planned liquidations. Another idea is to transfer a fixed portion of a bond portfolio into cash each time the Fed makes a rate move. For example, moving 5% of bonds into cash each time the Fed raises rates would result in 50% liquidation of bonds (into cash) over 10 moves. Note: The Fed technical made its first "rate move" of the new cycle on February 19, 2010, increasing the discount rate by .25%, to 0.75. However, no change was made in the more important target fed funds rate.

You can track historic and real-time Fed moves here: http://www.newyorkfed.org/markets/statistics/dlyrates/fedrate.html

Idea #3 – Ask your retired clients and prospects the really important question:"Why do you think money market and CD yields have dropped so low – and stayed so low, so long?"

This question will help you understand investors' goals, needs and attitudes, and it also can help to engage in conversations about current economic realities.

Retired people aren't "yield poor" because of natural economic or free-enterprise forces. They are yield poor because the Bernanke Fed has engineered and maintained a ZIRP policy that was a few years ago an unthinkable idea for the U.S.

Now that ZIRP has become all too real, retired people should rethink their income strategies and the potential to protect assets and income against inflation, or more government/Fed manipulation.

By asking the right questions and offering sound advice and suitable recommendations, you can be their guide to "the new ZIRP World." In other words, don't try to fight the disappointment and disillusionment of today's senior savers and investors.

It's real and growing bigger – so plug into it!