With interest rates expected higher for longer, what to do with cash
Americans holding cash just got some good news from the latest inflation report. With consumer prices rising faster than expected , the odds of a Federal Reserve rate cut happening soon appear slim. In fact, traders have pushed back expectations for a Fed cut until September, according to the CME FedWatch Tool . At one point they were expecting the reductions to start in June. They’ve also dialed back the number of reductions expected this year. That means those saving cash in money market funds and Treasury bills can expect to see their rates stay higher for longer. The annualized seven-day yield on the Crane 100 list of the 100 largest taxable money funds is currently 5.13%. “Money fund yields may not even drop below 5% at this point and won’t fall until after the Fed moves,” said Peter Crane, founder of Crane Data, a firm that tracks money markets. The appetite for money market funds is evident in the record amount of cash pouring into the products. Last week, there was $6.11 trillion sitting in money market funds, according to the Investment Company Institute , up from $5.87 trillion in mid-December. “With short-term rates still at very attractive levels, I’d expect inflows to money market funds to resume after tax season is over,” said Shelly Antoniewicz, ICI’s deputy chief economist. Maximizing savings Money market funds and high-yield savings accounts are a good place to park money for emergencies and other immediate spending needs because they are liquid, said certified financial planner Marguerita Cheng, CEO at Blue Ocean Global Wealth. If you have six to 12 months of living expenses set aside and have cash left over, you can then consider laddering some certificates of deposit, she said. Just be aware that if you withdraw from a CD before the maturity date, you’ll get penalized. Laddering is typically splitting money across several CDs of varying maturities. However, you can also buy one short-term CD every few weeks, said Cheng, a member of the CNBC Financial Advisor Council . She doesn’t suggest going out more than 18 months since short-term rates are higher than long-term ones. For those who have met their savings needs, Cheng suggests then using excess cash for your retirement account. She specifically likes Roth individual retirement accounts, which have income limits . Cash in your investment portfolio CFP Barry Glassman, founder and president of Glassman Wealth Services, likes cash because it has multiple purposes. “It is there for an emergency fund. It is there for spending, so if there is a market downturn, you don’t have to sell stocks at a low,” he said. “But also today the added benefit is that the risk/return is attractive and it is a diversifier.” He prefers Treasury bills, which have terms ranging from four weeks to 52 weeks. “With rates where they are today, short-term investments are no longer just a place of safety, it is a sub asset class,” said Glassman, another member of the CNBC Financial Advisor Counci l. He considers T-bills part of an investor’s overall bond portfolio. For his more conservative clients, he’s built up the short-term portfolio quite a bit. For more aggressive investors, there are fewer T-bills. That lines up with a recent Vanguard report , which found that the level of cash in portfolios depends on the investor’s risk tolerance, investment horizon and funding level. For those with a lower risk tolerance, who may not invest and save otherwise, having 10% to 15% in cash is fine, said Roger Aliaga-Diaz, Vanguard’s global head of portfolio construction. “It is important that you keep saving and investing toward your goal,” he said. “I would rather give you a more conservative portfolio that lets you sleep at night.” Cash also makes sense for those who are getting closer to their goal, whether it’s paying for college or drawing on retirement savings. For those investors, 20% to 30% is a good allocation — or even slightly more if you are really close to your goal, Aliaga-Diaz noted. “If you feel the funding levels are at the right level you need, you don’t want to risk that in the market,” he said. Then there are moderate risk investors with longer time horizons, which Vanguard surveys show are the majority of investors, he said. Their optimal cash allocation is zero, he said. For one, cash has barely kept up with inflation. Vanguard’s analysis shows that cash produced an annualized real return of 0.7% from 1960 through 2022. Stocks, on the other hand, saw a 6.3% annualized real return while bonds returned 2% after inflation. The asset manager also analyzed portfolios aimed at retirement and college savings, which found that as much as 50% came from the return in the market. “Putting money in a low-returning asset like cash, you are really going to reduce the wealth accumulation,” Aliaga-Diaz said. As for those who want to have cash set aside to take advantage of market dips, he cautions against that. In fact, Vanguard research shows that if an investor misses just a few weeks of a recovery, they underperform — and would have been better off riding the market down and back up again, he said. “If you could perfectly time the market, cash would work,” he said. “The problem is that it is so difficult to get out and back in” at the exact right time.
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