Cash yields are cooling. Here are alternatives for short-term dollars

It’s only been two weeks since the Federal Reserve cut interest rates for the first time in more than four years, but investors are already getting paid less to park their extra cash. Central bank policymakers trimmed a half point from the fed funds rate in September, bringing it down to a range of 4.75% to 5%. Two more cuts, totaling another half point, could be in the cards by the end of the year, provided the economy performs as expected, Fed Chair Jerome Powell said on Monday . That means that the days of 5% yields on idle cash are largely in the past, at least for the current cycle. The Crane 100 Money Fund Index had an annual 7-day yield of 5.1% at the end of August, and just over a month later it’s fallen to 4.75%. “The market is telling you that it’s not just the fed funds rate [that] will be lower, but so will the rest of the yield curve,” said Arvind Narayanan, senior portfolio manager and co-head of investment grade credit at Vanguard. “You get paid to go a little further [out] on the curve.” For long-term investors, the appropriate move ahead of a further decline in rates has largely been to add exposure to bonds with a duration of five to seven years. Those who want to squeeze a little more interest income out of cash they’ll need in the next 12 to 18 months, however, will need to assess their options. Lock in with ladders Three key considerations for investors holding cash would be liquidity, yield and risk. Financial advisors are still loving high-yield certificate of deposits, even as banks are starting to pull back some of their offerings. “If there are more cuts [from the Fed], things will shift, and they already have for money market funds,” said Anna Sergunina, certified financial planner and CEO at Main Street Financial Planning in Los Gatos, Calif. She prefers building a ladder of CDs – for instance, using a lump sum to buy 9-, 12- and 18-month instruments in one shot – to help clients take advantage of today’s relatively higher rates. Splitting the money this way also gives investors flexibility and can help deter them from having to “break,” or redeem, a CD ahead of maturity in the event money is needed sooner, Sergunina said. Investors can also buy a few short-term Treasury bills with staggered maturities in one go. There are two added benefits for T-bill ladders. First, the money is backed by the full faith and credit of the U.S. government. That protection goes beyond the Federal Deposit Insurance Corporation’s protection of up to $250,000 per depositor and per insured bank. Second, interest from Treasury bills is subject to federal income taxes, but it’s exempt from state and local levies. CD interest is taxed as ordinary income at state and federal levels. For clients who want ready access to their cash, a high-yield savings account could be a solid bet, Sergunina said. Consider that LendingClub offers 5.3% APY on savings , provided clients can deposit $250 a month. The catch with savings accounts is that banks can always adjust their yields, while CDs lock in rates for the duration of the instrument. “You can still get some really good interest, but it requires more monitoring,” said Sergunina. “The next time the Fed cuts rates, you’ll have to keep it in mind.” A little more interest in exchange for some risk For investors willing to take a bit of risk with their cash in order to generate some more yield, ultrashort bond funds could be worth considering. These funds generally have very limited duration exposure – they tend to have less price sensitivity to fluctuations in rates – and they hold floating rate securities, along with other short-dated instruments. “You’re getting more yield because you’re buying credit securities with some spread,” Narayanan said. Ultrashort bond funds do bring some element of risk: A few of them took their lumps in 2008 during the financial crisis, as they held risky nonagency mortgage bonds and investors cashed out, Amy Arnott, portfolio strategist at Morningstar, wrote in 2023. Investors in ultrashort bond funds will want to keep an eye on credit quality and ensure the fund manager isn’t reaching too far for yield. Fees also matter, as expense ratios that are too high erode returns. “Investors will take [net asset value] risk relative to money market funds, but we think this is the right time in the cycle to do that,” Narayanan said. “Duration and rates should act as a tailwind.” Offerings in the space include Vanguard’s Ultra-Short Bond ETF (VUSB) , which has a 30-day SEC yield of 3.9% and an expense ratio of 0.1%, and the Pimco Enhanced Short Maturity Active ETF (MINT) , which has a 30-day SEC yield of 5% and an expense ratio of 0.35%.