Americans Are Hoarding Cash Despite Expected Fed Rate Cut: Here’s Why Experts Say You Should Make a Move
While the Federal Reserve is widely expected to lower interest rates next week, Americans continue to pile their cash into money market funds. This trend, driven by attractive yields, raises concerns among financial experts, urging investors to consider alternative strategies to maximize their returns.
Key Takeaways:
- Record inflows into money market funds: Assets in money market funds reached a record high of $6.3 trillion in the week ending Wednesday, driven by their appealing payouts.
- Experts anticipate slowing inflows but not outflows: While the Fed’s rate cuts are expected to slow down the influx of cash into money market funds, experts believe outflows are unlikely unless the cuts are significantly deeper than anticipated.
- Shifting investment landscape: Historically, when investors move out of money market funds, they tend to favor fixed income over equities.
- Maximizing returns beyond cash: Financial advisors suggest diversifying investments beyond money market funds, especially with upcoming interest rate reductions.
- Strategic allocation for different investment horizons: Experts recommend allocating cash based on specific needs and investment goals, exploring options like CDs, investment-grade corporate bonds, and even preferred stocks.
The Allure of Money Market Funds
The recent surge in money market funds is fueled by their attractive returns. With the annualized 7-day yield on the Crane 100 list of the 100 largest taxable money funds currently at 5.08%, these funds are offering compelling payouts to investors. Bank of America predicts that these inflows will continue despite the looming Fed rate cuts.
While the Fed is anticipated to reduce rates – a majority of traders expect a quarter-percentage-point reduction at the upcoming September 17-18 meeting – experts believe that these cuts are unlikely to significantly impact the flow of cash out of money market funds unless they drop below 2%.
Why Diversify Now?
While holding onto cash can seem appealing, financial experts caution against holding too much. Ted Jenkin, a certified financial planner and founder of oXYGen Financial, advocates for a strategic approach, suggesting that investors should determine how much cash they need for emergencies and potential future opportunities or purchases. Such funds can be comfortably kept in liquid assets like money market funds or high-yield savings accounts.
For funds with a longer investment horizon, certificates of deposit (CDs) can be a viable option, but Jenkin advises acting quickly. "If you want to maximize return on your cash for the next 12 months, it is probably best to lock in 9-month or 12-month CD rates," he explains. "They are at the height of where they are going to be as the Fed is going to lower interest rates over the next 12 months."
Beyond Cash: Exploring Fixed Income and Preferred Stocks
Once investors have secured their emergency and short-term liquidity needs, experts recommend transitioning excess funds into fixed income. "It is a great time to increase the duration of your bonds," Jenkin insists. He specifically favors five and 10-year investment-grade corporate bonds, echoing the sentiment of Leslie Falconio, head of taxable fixed-income strategy at UBS Americas’ chief investment office, who identifies the 4½-year to 5-year segment of the curve as the "sweet spot."
"We have had a record amount of issues in investment-grade corporate the first week of the month, but the investor demand is still there," Falconio observes. The robust demand ensures strong yields for investors seeking quality assets.
Falconio also advocates for agency mortgage-backed securities, praising their high quality and liquidity. These securities, backed by the U.S. government, offer relatively lower credit risk due to their close ties to a pool of mortgage loans issued by entities like Fannie Mae, Freddie Mac, and Ginnie Mae.
Jenkin highlights another promising avenue for investment: preferred stocks. These securities, considered hybrids of stocks and bonds, tend to perform well during periods of declining interest rates.
"This is the forgotten asset class," Jenkin declares. "It’s a good time to own them because they are going to continue to pay a consistent yield and will also see price appreciation."
Navigating Interest Rate Uncertainty
The anticipated Fed rate cuts create a dynamic investment landscape. While the current yields on money market funds remain appealing, the potential for future reductions necessitates a proactive approach to portfolio management.
By understanding the different investment horizons and leveraging the strengths of various asset classes, investors can navigate this uncertain terrain and optimize their returns. With a blend of liquidity, fixed income, and preferred stocks, investors can position themselves for success in the face of evolving market conditions.