Cash isn’t just the dollar bill you put in your pocket – in this market, it can seem like a piece of stable ground.
There are many options: People can put their money in high-yield savings accounts, checking accounts, money market mutual funds, certificates of deposit and short-term Treasury loans.
As a super-safe alternative to equity markets, these investment vehicles are positioned to yield higher returns from higher interest rates. When recession worries persist, and stocks and bonds look to recover from 2022 declines, they may seem like reassuring places to put money.
According to DepositAccounts.com, the average high-yield online savings account has a 3.3% annual percentage yield (APY), up from less than 0.5% a year ago. The site said one-year online CDs average 4.4% APY, up from about 0.6% a year ago.
According to industry tracker Crane Data, the average seven-day yield for the 100 largest money market funds is 4.34% and hasn’t been that high in more than a decade. With maturities less than one year, Treasury bills are yielding 4.5% or more.
Of course, those numbers aren’t outpacing inflation. December’s annual inflation rate through June 2022 was 6.5%, down from the pandemic-era high of 9.1%.
But consider these cash returns in comparison to the performance of the stock market. Even with a strong start to January, the Dow Jones Industrial Average DJIA is down more than 4% year to date. In that time, the S&P 500 SPX is up 9% and the Nasdaq Composite Comp.
There was a loss of about 17 percent.
A large part of the downward pressure is the Federal Reserve’s rapid rise to its benchmark interest rate. The Fed raised its key rate by 25 basis points, which is a quarter of a percentage point, last week and Chairman Jerome Powell has said more hikes are needed to help puncture inflation.
“There’s more curiosity about cash,” said Megan Dow, senior strategist for client needs research at Edward Jones. “Any time we see market volatility and investments start to feel less certain, cash starts to feel more comfortable and feel more secure as a place to put their money.”
Financial advisor Ryan Greiser said he was surprised by how much idle cash was sitting around waiting for more productive use from clients. He isn’t reducing stock and bond allocations, but he is putting the extra money into short-term CDs and Treasury bills. “Cash is the coolest kid on the block right now,” said Greiser, a certified financial planner with Opulus based in Doylestown, Pa.
Take it from Ray Dalio. “Cash used to be trash,” the founder of massive hedge fund Bridgewater Associates said in a CNBC interview last week. “It’s attractive with respect to bonds. It’s really attractive with respect to stocks.”
John Boyd, founder of MDRN Wealth in Scottsdale, Ariz., disagrees. Cash is not garbage for him. This is a trap.”
“One of the biggest mistakes I see investors making right now is getting out of depreciating stock and bond funds to take advantage of the higher yields. [high-yield savings accounts]money market funds and even short term CDs,” he said.
Take advantage of higher rates for rainy day money and reserves — just don’t overdo it, Boyd said. Boyd said cash still doesn’t have “double-digit growth potential like stocks.”
Dow said there are four reasons to hold cash as a liquid asset. This is for everyday expenses, emergency savings, large upcoming expenses like down payment on a home and as part of an investment portfolio.
Edward Jones generally recommends having no more than 5% cash exposure in an investment portfolio, Dow said. “You don’t want too little, but you don’t want too much either,” she said.
A “cash management plan” is an important part of financial and investment planning, said Rob Williams, managing director of financial planning, retirement income and wealth management at the Schwab Center for Financial Research, a division of Charles Schwab & Company SCHW.
It is common to hear financial experts describe cash investments as a spectrum of options where there is a trade-off between returns and liquidity.
In addition, here are places to park your extra cash:
checking and savings accounts
Some checking accounts pay higher interest than traditional checking accounts. But there are some caveats, explained Ken Tumin, senior industry analyst at LendingTree and founder of DepositAccounts.com.
He noted that many high-yield checking accounts require a minimum number of transactions for the APY, usually between 8 and 20. There is often a cash limit on higher APYs, typically between $10,000 and $25,000, she said. So if you want to park money above those caps, it won’t generate the same amount of interest as a high-yield savings account, he said.
“In many cases, the rate advantage for a high-yield checking account on a high-yield savings account may not be worth the effort,” he said. But the rate advantage between savings accounts at “brick and mortar” banks and online banks is notable, he said.
Tumin cited FDIC data that shows the national average rate for savings accounts was 0.33% as of mid-January. Without the overhead costs of brick-and-mortar competitors, Tumin said online banks offer interest of up to 4.20% on some savings accounts as they seek an edge over competitors.
Brokerages also offer “sweeping” services, which sweep up uninvested money while it sits for the next trade.
For example, Robinhood Hood deposits eligible customers’ non-invested cash into a deposit account at a network of banks, beginning in February with 4.15% APY. A spokeswoman said Fidelity Investments automatically puts the cash into a money market fund, which as of early February was offering a 4.14% seven-day yield.
At Interactive Brokers IBKR, inactive cash balances over $10,000 can remain in an account and earn interest. The formula is based on the federal funds rate minus 50 basis points, said Steve Sanders, executive vice president of marketing and product development. For now, it’s a rate of 4.08%.
money market funds
Williams said that money market funds occupy a middle ground. Yields can run higher than on savings accounts, although it usually takes about a day to redeem your holdings, he said.
These mutual funds consist of elements such as short-term, high-quality federal government and municipal debt as well as high-grade corporate debt that is early maturing.
As of the end of last year, money market funds had $5.2 trillion in assets under management, according to the Treasury Department’s Office of Financial Research. Data shows that it has over $4 trillion in assets under management as of February 2020.
According to Peter Crane, president of Crane Data, it will be weeks before the latest 25 basis point increase is fully reflected in average yields.
The last time the largest money market funds average seven-day yield exceeded 4% was in December 2007, according to data from Crane Data. “Their biggest weakness is now their biggest strength. They follow the Fed,” Crane told MarketWatch.
As yields spread from many savings accounts and money market funds, consumers should look more closely at these vehicles, said Kyle Simmons, founder and principal financial advisor at Simmons Investment Management in the Denver area.
Ultra short-term ETFs are another option, he added. Like money market funds, they give exposure to government and high-quality corporate debt that mature quickly.
But don’t confuse money market funds with money market accounts. The two are completely different, Tumin said. He said that the money market account of the bank is similar to the savings account.
CDs and Treasury Bills
On the other side of the cash spectrum are Treasury bills and CDs. Their maturity period ranges from 4 to 52 weeks. The yield may be higher than money market funds, but you will have to wait longer to get your money back.
The market yield on one-month Treasury bills is currently above 4.6%, according to Fed data. The yield for one-month T-bills last exceeded 4% in October 2007, according to data from the St. Louis Fed, on a rolling basis.
Investors can buy Treasury loans of varying lengths through their broker or at TreasuryDirect.gov. (TreasuryDirect is also a place to buy the popular I-Bonds, but they cannot be purchased on the secondary market.)
Interest from T-Bills are subject to federal income tax, but they are exempt from state and local taxes, Greiser said. It can provide an “edge over CDs depending on the interest rate differential and an individual’s tax situation,” he said.
The secondary market for T-bills is larger than for CDs, and it makes it easier to get out early if you need the money before maturity.
One tip for CDs and T-bills with longer maturities: Buy them with the view that interest rates will go down while the money is tied up. (“In our view, we are not in that climate right now,” Williams said. At the Fed, Powell has said that rates will have to be kept high “for a long time.”)
Of course, money held in T-bills or CDs remains temporarily on the sidelines, for better or for worse. “If the market takes off like a rocket while you parked your money, well, you can leave a little behind. That’s the price you pay for less risk,” Greiser said.
Williams said that any sort of manipulation of money in CDs or elsewhere should not be the overall goal for this part of a person’s wallet and portfolio. “Cash is ultimately for yield and stability, which is the safest part of your financial life.”
Read also: Dear Tax Guy: Can I Deduct the Early Withdrawal Penalty if I Switch to a Higher Rate CD?
Source: www.marketwatch.com
