With short-term interest rates rising to the highest levels seen in the last 15 years, now is a good time to examine where your cash is parked. In recent memory, cash has not been able to generate income. It was essentially earning nothing and on a real return basis, it was negative. From 2010-2019, bank savings accounts, Certificate of Deposits and money market interest rates fell to their lowest point in US history with rates barely above zero percent. The recent Fed action has driven 3-month T-Bill yields up from 0.5% in January 2022 to 3.4% in early October. While we don’t advise keeping a large balance of cash over the long-term, in the short term you are at least earning a decent rate until markets settle down to implement your targeted investment strategy.
There are two principal ways to generate higher returns on your cash but you will have to actively manage this process versus letting it sit in the bank.
It should be noted that bank savings, money market and CD accounts do not move with the markets, unlike money market funds and treasury securities. Bank and CD rates are priced by individual banks and are a function of deposit supply and loan demand. Consumer behavior leans toward inertia, but in this instance, it makes financial sense to move your money out of the bank account paying lower interest rate and into one of the higher interest-bearing investments described above. Both money market funds and treasury securities are relatively easy to purchase and should be a part of your investment strategy.
The first option is to invest in money market funds. These are professionally managed mutual funds that invest in highly liquid, short-term investments such as short-term U.S. Treasury securities, Eurodollar deposits, repurchase agreements and CDs. They are created to offer investors high liquidity with a very low level of risk. The current yields on money market funds are 2.5% or higher. Fees on money market funds are very low, so it is a cost-effective way to generate short-term interest with liquidity.
Money market funds should not be confused with Money Market Accounts (“MMA”) offered by a bank. A Money Market Account is a higher interest savings account at a bank whereby its principal is insured by the FDIC (up to $250,000 per person, per insured bank, per account). Both types of accounts offer low-risk, highly liquid investments, but money market mutual funds tend to offer higher returns. For example, the current Bank of America MMA rate is 0.01% - 0.04% per year, depending on the dollar balance, but Fidelity money market funds are yielding between 2.58% - 3.06% depending on balance.1
The second investment strategy is to invest in short-term US Government Securities such as T-Bills. US Government securities are generally the lowest risk security you can purchase as they are backed by the full faith and credit of the US Government. The 3-month T-Bill is often referred to as the “risk-free” rate in investment analysis. As of October 5, 2022, the 3-month T-Bill is yielding 3.4% and the 6-month T-Bill 4.1%. Treasury securities can be purchased from brokers or from Treasury Direct (click here). They are purchased with no fees or sales charges, and interest from US Government Securities are generally exempt from state and local taxes. Some investors are building their own “ladders” of treasury securities, i.e., purchasing a series of T-Bills maturing at one-month intervals to provide extra monthly income in the near term. This protects investors from having to dip into their equity and bond portfolios at depressed valuations for cash spending needs.
It is also worth looking into whether or not your cash is sitting in a “sweep” account at your brokerage firm. A sweep account collects dividend and interest payments and funds near-term cash flow needs. However, the average interest rate on a sweep account as of September 23rd is 0.29%2. Again, you should hold the minimum in a sweep account and the rest should be moved into a higher earning account as outlined above.
While cash is not as exciting as the latest technology stock, it plays an important role in your portfolio. Your cash balance is there to help meet daily living and emergency expenses and sometimes, is a placeholder for money waiting for deployment into an investment plan. Nowadays investors can actually get a little excited about cash as there are some attractive returns which we have not seen in years.
1 Source: Bank of America and Fidelity.
2 Source: Crane Data.