Parking cash is no longer a dead end. Eleven hikes in interest rates from the Federal Reserve have put savers back in the driver’s seat.
The key, though, is to make the most of the cash you have laying around.
Reaping the benefits of a plump 5%-plus yield on cash is only possible if you shop around for the best rate, switch to a financial institution that treats your cash better, and defeat the enemy known as inertia.
Now’s the time to move if you still have a pile of cash in a savings account paying just 0.01% in interest. You can get a lot more at a different bank.
High Interest Rates Takes More Than Intentions
You must ask yourself, “Is having good intentions enough?”
“The answer is always, get off your butt,” said Michael Green, chief strategist at Simplify Asset Management.
Indeed, managing your cash is just as important as managing your stock portfolio. Proper cash management is critical to coping with financial emergencies, generating enough income to pay the bills (especially for retirees), and giving your idle cash a chance to grow as much as it can.
Even though the Fed in September kept its key short-term rate steady at a range of 5.25% to 5.5%, that doesn’t mean you’ve missed the chance to make your cash work harder for you, says Matthew Goldberg, a consumer banking expert at Bankrate.
The starting point for short-term yields set by the Fed is at the highest level in more than 20 years, and the yield on the 10-year U.S. Treasury, which topped 4.9% Wednesday, is at a fresh 16-year high.
Great Time For Savers
“It’s not too late,” said Goldberg. “It’s still a really great time for savers. It always pays to shop around and find the best yield and account for your needs.”
Yields on FDIC-insured high-yield savings accounts as well as money market funds now offer a positive real return, as rates earned on cash are higher than the latest 3.7% inflation reading, says Goldberg. These accounts are also stable and very liquid, which means you can access your money fast, and have essentially zero volatility.
While market players won’t rule out another Fed rate hike if inflation remains sticky and the economy remains resilient, they don’t believe the Fed is in a rush to lower rates. There’s only a 31% chance the Fed will lower rates by a quarter of a percentage point by June 2024, according to CME Group’s FedWatch Tool.
And that’s a good thing, as savings accounts and money market accounts move in tandem with Fed policy moves.
“You’re going to continue to be able to generate 5%-plus out of a money market until the Fed decides to move rates lower,” said Green. “And the nice thing about (this part of the fixed-income market) is you’re going to know exactly what return you’re going to get.”
Getting In Position For Higher Interest Rates
But personal financial experts also urge savers to start thinking about how to position idle cash for the next Fed rate-cutting phase.
“You need to be thinking about where the Fed goes next,” said Thomas Urano, co-chief investment officer at Sage Advisory.
Because if the Fed starts to cut rates, the yields on high-yield savings accounts and money market funds that look attractive now will fall. “Your income is going to be eroded,” Urano said. A $1 million portfolio, for example, that yields 5% throws off $50,000 in income each year. But if rates fall to 3%, your annual income drops by 40% to just $30,000.
The take-away: Where to stash cash and what types of asset classes you can utilize to maximize yield may differ based on short-, medium- and long-term time horizons.
Here are some strategies to keep the yield you earn higher for longer.
Mind Short-Term Needs
Short term money is cash you need yesterday. It’s money you can tap quickly to pay for an unexpected home repair or condominium assessment, or to fund a pricey car maintenance due in a few months.
This money should be deposited in a high-yield savings account or money market fund which now sport yields north of 5%. A recent search of Bankrate.com found a high-yield savings account with an annual percentage yield, or APY, of 5.4%.
“Liquidity is the key,” said Sam Millette, director, fixed income at Commonwealth Financial Network. “If you need to tap the account in the next couple of months, that’s generally what we’re suggesting.”
Find Mid-Range Solutions
Let’s say you don’t need your cash for say a year to 18 months, or you think rates may fall. Investing in an ultra-short-term bond fund (invests in investment grade bonds with average maturities of 18 months or less) or short-term bond fund (typically with maturities ranging from one to three years) might give you a tad more yield and protect you against interest rate fluctuations, says Millette. Short-term bond funds are less sensitive to both interest rate and credit risk
For example, if yields rise a tiny bit more, your principal will be less impacted by the rate increase, and you’ll benefit from the higher yield when your fund reinvests new money. And if rates dip, you’ll earn a little capital appreciation, as bond prices rise when yields fall.
Investing in a diversified mutual fund or ETF is a good way to go. IBD Best Mutual Fund winner T. Rowe Price Ultra Short-Term Bond fund (TRBUX), for example, is a low-risk way to squeeze out incremental yield above what you’d get in a money market fund.
Find Higher Interest Rates For Longer Plays
With the Fed likely nearing the end of its rate-hike cycle, it’s a little trickier to figure out ways to lock in higher yields. “It gets harder,” said Green.
But there are a few ways to play it.
One strategy is to shop around for the highest yielding certificates of deposits, or CDs. You can build a CD ladder which gives you exposure to CDs with different maturing dates. A recent review of top-yielding CDs at Bankrate.com shows the highest-yielding 1-year CD at 5.67%, a 2-year at 5.15%, 3-year at 4.85%, and 4- and 5-year CDs at 4.65%.
So, if you’re betting that rates will fall, you could put equal amounts of money in CDs ranging in maturities from one to five years. You’ll get the benefit of the hefty 5.67% yield on a 1-year CD and lock in rates close to 5% (4.65% for a 5-year CD) for up to five years. If rates rise, of course, you will be able to reinvest at the higher rate as CDs in the ladder mature.
“If it’s money you’re not going to touch for a few years and you want a fixed annual percentage yield, then a CD ladder could be a great option,” said Bankrate’s Goldberg.
What If Interest Rates Fall?
Another option is to invest in a diversified fixed-income portfolio, which invests in investment grade bonds, such as corporates, mortgage-backed bonds and U.S. Treasuries, says Sage Advisory’s Urano.
A good way to get broad exposure is via the iShares Core U.S. Aggregate Bond ETF (AGG) that charges an expense ratio of just 0.03%. If equities normally return 8% to 10% per year, on average, you can get a mid- to high-single digit percentage yield in a diversified bond fund with a much less bumpy ride.
“Fixed income with lower volatility looks much better,” said Urano.
And if rates do eventually decline, you’ll get some capital appreciation, too.
“If rates do go lower, you want to be positioned in a portfolio that can either deliver you that yield for longer, or which benefits from rising prices as rates go down, and also maintain some semblance of liquidity,” said Urano.
For example, if rates fall 1% on an intermediate-term bond fund with a duration of 6.3 years that yields 4.9%, you’re getting an additional return of “more than 6%,” said Millette. “It really does create a total return (e.g., capital appreciation plus yield) potential that can be pretty attractive.”
Go Long With Treasuries?
Another option for those betting on an eventual rate drop is to invest directly in a 10-year Treasury, which is now yielding about 4.9%, adds Green. The benefit of owning a Treasury is you don’t have to lock up your money like you do with a CD, plus the interest rate risk given the current level of rates is relatively small. Plus, you could earn bigger returns than a 5-year CD if the Fed cuts rates, he adds.
At this stage of the market cycle, it makes sense to take a “barbell approach” to your portfolio so that you can take advantage of the current short-term yields but also benefit from capital appreciation if rates fall, says Green.
Now’s the time to “start hunting for longer-term exposure,” said Green.
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