Cash management and investing strategies when interest rates are up | U.S. Bank (2024)

A persistently high interest rate environment has attracted $6 trillion to low-risk, short-term money market funds.¹ However, it’s important to be aware of the potential ramifications if, as expected, interest rates start to decline.

“An environment featuring today’s competitive yields may have given people a false sense of security about the benefits of lower-risk, short-term instruments,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “Yet 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 after a recent setback, total returns are still up nearly 15% year-to-date as of early August.²

At the same time, investors are closely monitoring the Federal Reserve (Fed) as it considers weighs potential interest rate cuts. The Fed sets the target fed funds rate, which currently stands at the unusually high level of 5.25% to 5.50%. Other short-term rates, such as those of money market funds, tend to align with the fed funds rate. However, markets today anticipate that the Fed will begin to cut the fed funds rate as early as September.³ That could mean investors will have to lower their expectations for earnings on money invested in short-term instruments such as money market funds.

Accounting for inflation

Haworth says investors also need to consider the impact of higher living costs as they compare returns of different types of securities. “Although fixed income yields look much more attractive today than they did a few years ago, this comes at a cost,” says Haworth. “Investors must keep in mind that inflation, even though it has come down, is still higher than in previous times, and that’s 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 2.9% for the 12-month period ending July 2024.⁴

Haworth encourages investors to broaden their horizons, as appropriate for their circ*mstances. “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.” This includes a mix of stocks, real assets and longer-term bonds.

Prioritizing portfolio objectives

Haworth says it can be helpful for investors to consider how investable assets are allocated to meet both short-term and long-term goals. “Some of your funds should be positioned in cash instruments to meet more immediate needs, but money that is intended to achieve long-term objectives should be invested in assets like stocks and bonds to work toward those goals.”

For cash needs, consider separating your assets into two categories:

• Money set aside to meet current and pending cash flow needs for the next 0-to-18 months
• Money intended to meet longer-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.

Positioning for long-term goals

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. “In fact, despite today’s elevated yields for cash vehicles, a diversified portfolio of stocks and bonds likely generated superior performance in 2023, and year-to-date in 2024.” Haworth says investors holding money in cash that is intended to help meet long-term goals should consider ways to put it to work more effectively.

“A first step is to move cash into short-term, lower-quality fixed income instruments that pay more attractive yields given the recent change in the interest rate environment,” says Haworth. He says investment grade corporate debt provides competitive rates, with municipal bonds also offering even more attractive tax-equivalent yields for individuals in higher tax brackets. Other options to consider are FDIC-insured bank savings accounts, which typically provide immediate liquidity, and certificates of deposit, available for various holding periods. Both vehicles offer more competitive yields than was the case prior to 2022.

Fixed income investments

Haworth says another sensible step may be to consider longer-term fixed income securities. “Once Fed rate cuts occur, yields will drop on short-term instruments,” 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 while managing total duration with long-maturity U.S. Treasuries.

Equities

Beyond the bond market, Haworth suggests that investors consider building a larger-than-neutral weighting in equities. “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 commodities and 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.

The opportunity cost of too much cash

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, when the S&P 500 reached new highs for the first time in more than two years.

How your views on risk affect your approach to cash and investments

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.

Consider your cash management and investing opportunities

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.

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