Key takeaways
Investors today hold more than $6 trillion in money market funds.
Investors have capitalized on higher interest rates available on shorter-term securities.
However, the interest rate environment is changing, as the Fed starts to cut interest rates.
Investors attracted by what had been historically attractive interest rates continue to maintain significant funds in cash-equivalent investments. For example, over much of 2024, investors held more than $6 trillion in low-risk, short-term money market funds.1 While investors may appreciate the security of what are generally considered risk-free, liquid investments, cash vehicles are best utilized for specific purposes.
“It's important to distinguish ‘investment cash’ from cash needed to meet regular or emergency expenses,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “If you are investing to grow wealth and meet future lifestyle needs, most investors should hold virtually no cash in their long-term portfolio.”
“Those who continue to put money to work in cash-equivalent vehicles as an alternative to stocks have, since late 2022, missed out on what proved to be an impressive period for stock market returns,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management.
This may be even more true in an environment where the Federal Reserve has begun cutting the federal funds target interest rate which guides overnight lending rates between financial institutions. From early 2022 to mid-2023, the Fed raised the fed funds rate from near 0% to a peak of 5.50%, then held it at that level for more than a year. Things changed in September 2024, as it cut the fed funds rate by 0.50%, the first of what is expected to be a series of rate cuts. In light of the Fed policy shift, investors should lower their expectations for earnings on money invested in short-term instruments such as money market funds.
Even before the Fed acted, yields on bonds and cash instruments fell from peak levels. If the Fed follows through on additional rate cuts, that trend is likely to persist. Haworth, points out that even when rates were at their highest levels, “Those who continue to put money to work in cash-equivalent vehicles as an alternative to stocks have, since late 2022, missed out on what proved to be an impressive period for stock market returns.” The benchmark S&P 500 stock index generated a total return of more than 26% in 2023 and even given a more volatile environment recently, S&P 500 total returns toward the end of September 2024 are up about 20% year-to-date.2
Similarly, longer-term bonds, even those with lower yields than shorter-term bonds in today’s unusual interest rate environment, have, in recent weeks, performed extremely well. “For months, we’ve been advocating that investors shift money from shorter-term to longer-term bonds,” says Haworth. “But many were slow to the opportunity.” Yields on the benchmark 10- year U.S. Treasury note, after peaking for the year in April at 4.70%, by mid-September fell to 3.63%. As bond values rise when yields fall, investors generated solid total returns during that time.
Haworth says investors also need to consider the impact of higher living costs as they compare returns of different types of securities. “Investors must keep in mind that inflation, even though it has come down, is still a primary risk to a portfolio as you assess the most effective way to structure your asset mix.” Inflation, as measured by the Consumer Price Index, stood at 2.5% for the 12-month period ending August 2024.3
Haworth encourages investors to broaden their horizons, as appropriate for their circumstances. “In today’s market, there is a lot of value to be found beyond cash-equivalent instruments,” says Haworth. “The key to investing is holding a diversified portfolio to meet a broad range of investment needs.”
Haworth says it can be helpful for investors to consider how investable assets are allocated to meet both short-term and long-term goals.
You may want to maintain up to 18 months’ worth of assets in accounts that offer some degree of immediate liquidity. These resources can be used to meet living and lifestyle expenses, tax liabilities and to repay debts. It’s also important to maintain at least a six-month emergency fund. For these purposes, consider higher yielding checking accounts, money market mutual funds or CDs.
For money that’s not needed in the next 18 months or so, but that may be required after that period, consider money market funds, Treasury bills and short-term bonds that may offer the potential to generate additional yield while still protecting principal.
As indicated in the chart, Treasury rates currently move lower as maturities increase (i.e., a six- month Treasury bill pays more than a 1-year Treasury bill, which pays more than a 2-year Treasury). This is an unusual situation, but Haworth notes that tax-sensitive investors who put money to work in municipal bonds must realize that a different yield environment exists in the tax-free market. “As opposed to the case for taxable bonds, municipal bond yields are tracking along a normal yield curve,” says Haworth. “Municipal bond investors can earn higher yields as they move farther out on the maturity spectrum.
Resources not needed for near-term purposes can be invested with the objective of generating more attractive, longer-term returns. “Historically speaking, a diversified portfolio emphasizing stocks and bonds will outperform cash,” says Haworth. He recommends investors holding money in cash that is intended to help meet long-term goals consider ways to put it to work more effectively.
Haworth says another sensible step may be to consider longer-term fixed income securities. “With the Fed actively cutting rates, it’s fair to expect that yields on short-term instruments will drop,” says Haworth. “In this environment, locking in one-year or two-year yields on Treasury bills at today’s higher rates may be a smart move to protect short-term cash.” Haworth adds that for investors seeking to achieve long-term goals, it may be an opportune time to put more money to work in longer-term fixed income securities. For tax-aware portfolios, investors may consider municipal bonds with slightly longer than average durations, with a modest allocation to high-yield municipal bonds. Within taxable portfolios, consider a meaningful investment in non-government agency issued residential mortgage-backed securities and AAA-rated collateralized mortgage obligations, while managing total duration with long-maturity U.S. Treasuries. Trust portfolios should consider reinsurance investments.
Beyond the bond market, Haworth suggests that investors consider building and maintaining their equity allocation. “Equities are likely to continue to benefit from positive economic growth, which will help corporate earnings grow.” He also suggests that real assets, such as real estate, offer an opportunity to protect against the impact of persistent inflation. In this environment, dollar-cost averaging can be an effective strategy for shifting funds into longer-term assets.
When investors hold cash for too long, it typically results in an opportunity cost, relative to their goals and their long-term portfolio strategy. “Investors often pull money intended to achieve long-term goals out of markets after prices have already declined, then are hesitant to get back in until the markets have already recovered,” says Paul Springmeyer, senior vice president and regional investment director at U.S. Bank Private Wealth Management. “This is the risk of trying to time the market,” he says. “Too often, investors are late to return and miss a major part of the rebound.” This was true of investors who stayed out of the stock market in 2023 and early 2024, as the S&P 500 frequently topped new highs.4
This may be a good time to reassess your own views about risk tolerance and determine if you want to adjust your portfolio. Springmeyer says for many investors, keeping long-term money on the sidelines turns out to be counterproductive. “It’s important to stay invested for the long-term to capture the opportunities that equities and bonds ultimately generate, without having to make decisions about whether the time is right to get into the market.”
Haworth also notes that along the way, changes may be appropriate. “It’s important to regularly rebalance a portfolio to reflect how market performance has changed your asset mix and bring it back to the intended allocation based on your risk tolerance, time horizon and goals,” he says.
It is not possible to predict with accuracy what to expect of the equity and bond markets in the near term. But if you have long-term financial goals, you should seek reasonable opportunities to put cash to work in ways that will help you achieve those objectives.
Review your financial plan with a wealth professional and explore cash management opportunities – along with your long-term investing goals – to help you capitalize on today's interest rate environment.
Note: The Standard & Poor’s 500 Index (S&P 500) consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. The S&P 500 is an unmanaged index of stocks. It is not possible to invest directly in the index. Past performance is no guarantee of future results.
In today’s market, in which investors can capitalize on very attractive yields on short-term assets such as money market funds, CDs and Treasury bills, significant money is held in cash-equivalent vehicles. However, it’s important that investors seeking to achieve long-term goals look for reasonable opportunities to put cash to work in ways that will help achieve those objectives. This includes using stocks, longer-term fixed income instruments and real assets such as commodities or real estate. A diversified mix of long-term assets is can help generate competitive returns over time. In an environment of elevated inflation, it is critical to position assets in long-term investments that can generate solid, after-inflation returns.
The term “cash equivalents,” from an investment perspective, technically refers to a range of short-term vehicles. This can include bank CDs, Treasury bills, commercial paper and instruments such as money market funds. To be considered liquid, the maturity date should not exceed 90 days. However, individuals investors will also categorize as “cash,” various relatively safe securities (CDs, short-term U.S. Treasury securities) as “cash,” within a broader portfolio.
You may want to maintain up to 18 months’ worth of assets in accounts that offer some degree of immediate liquidity. These resources can be used to meet living and lifestyle expenses, tax liabilities and to repay debts. It’s also important to maintain at least a six-month emergency fund. For these purposes, consider higher yielding checking accounts, money market savings or CDs. For money that’s not needed in the next 18 months or so, but that may be required after that period, consider money market funds, Treasury bills and short-term bonds that may offer the potential to generate additional yield while still protecting principal.
Instead of trying to time the market, consider buying stocks and other securities and holding on to them regardless of changes in the market. Read more about the benefits of this long-term investment strategy.
Seesawing between up days and down days, market volatility is roiling the stock market since the Federal Reserve cut interest rates for the first time since 2020.
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