For the first time in years, investors have some reasonable choices for investing their cash.
The Federal Reserve’s aggressive monetary policies following the financial crisis kept interest rates on traditional cash investments near zero. Investors either had to accept these low rates or take more risk to earn higher yields on their cash.
The situation has changed a lot since interest rates reached a bottom in July 2016.
While yields on cash investments still are low by historic standards, they recently offered the highest yields since 2011. Some people hold cash because they have what I call a safety fund and some others call the short-term investment bucket. In either case, this is a fund that’s equivalent to the amount of money you expect to need for living expenses in the next two to five years. You determine the period, depending on how conservative you want to be.
When you have an expense, it is paid from this fund. You replenish the fund from time to time with gains and income from the rest of your investment portfolio. The idea is that you know there’s cash set aside for the expenses you’ll need in the next few years. You’ll be less likely to panic during a market downturn by overhauling your investment strategy and selling near the lows.
Other investors keep a permanent allocation to cash in their portfolios, usually around 10%.
Some people have cash in their portfolios from time to time as part of their tactical investment strategies. They sell investments that appear to be near peaks and hold the proceeds in cash until attractive alternatives can be found.
Whatever the reason, the higher yields on cash mean you now should carefully consider how that cash should be invested. Here are key options to consider.
Money Market Funds.
Yields on many of these cash standbys recently went above 2% for the first time in years. The safest money funds invest only in U.S. Treasury debt; these also have lower yields. Others also invest in other federal debt, including issues from federal agencies or entities that aren’t explicitly backed by the treasury, such as debt from the housing finance agencies.
Broader-based money funds usually have the highest yields and also will invest in corporate debt. These often are known as prime money market funds. You also can invest in tax-exempt money market funds if you want to earn interest free of federal income taxes.
The Vanguard money market funds (which usually have among the lowest expenses) recently had these yields: Treasury: 1.95%; federal: 1.94%; prime: 2.10%; and tax-exempt: 1.22%.
Bank Certificates of Deposit.
A bank certificate of deposit (CD) has the advantage of being guaranteed by the FDIC up to $250,000. A CD has the potential disadvantage of being locked up for a minimum period of time you select.
When a CD matures, you either roll the proceeds into another CD or move the money elsewhere. CDs usually pay higher yields than money market funds and bond mutual funds with similar maturities. Recently, the higher-yielding one-month CDs nationally had annual percentage yields ranging from 0.30% to 1.35%. Six-month CDs had annual percentage yields of 2.30% and higher.
You can shop for yields at banks in your area or search nationally. Websites such as www.bankrate.com can help.
Most brokers and many mutual fund companies offer to put client money into CDs. One advantage of the brokered CD is you don’t have to move your money back and forth between banks and your investment accounts. It is all handled through one account and broker.
Another advantage is you might earn higher yields. A broker will search nationally and even internationally for attractive yields. For example, Vanguard recently was offering access to six-month CDs with annual percentage yields of 2.50%. These were offered by banks around the country and by U.S. subsidiaries of banks from other countries.
When you consider a brokered CD, be sure to specify you want only FDIC-insured CDs. Also, ask how the broker is paid and what the yield is on the money you actually have invested. If you invest $100,000 in a 2.50% CD but the broker takes a commission or fee before it’s invested, you’ll earn 2.50% on less than $100,000.
You can lend money directly to the U.S. Treasury. Most aspects of this service are free, so all the interest goes into your account. A potential disadvantage is when its time to spend or invest, you have to transfer money back to your brokerage or bank account.
There might be fees for wire transfers if you use them. Also, you’ll be bidding for treasuries at auction. You can’t invest the cash and won’t know the yield until after the auction. There’s the potential that there might be more bidders than securities available, so you won’t be able to invest all the money you wanted.
The service is now only available through the web site www.treasurydirect.gov.
Treasuries through brokers.
You might find it a little more convenient to purchase treasury debt through your brokerage account. If you buy already-issued treasuries on the market, the broker is likely to charge a mark-up, commission or other fee.
Some brokers now will facilitate purchases of newly issued treasury debt at little or no cost to clients. Check with your broker for its terms on treasury debt investments. You might find this is more convenient and about the same cost as using Treasury Direct.
Short-term bond funds.
In recent years, many investors have started using short-term bond funds for their cash investments. These pay higher yields than money market funds, because the duration of the debt is longer. Some fund companies also offer ultrashort bond funds.
Short-term bond funds usually have durations of less than two years. Ultra-short bond funds usually have durations of less than one year.
The potential disadvantage of these bond funds is you aren’t holding a security to maturity. When interest rates rise, the bonds held by the fund lose value and the fund’s share value declines. You’ll earn a higher yield than a money market fund, but you could lose the difference, and potentially more, by having the value of the fund shares decline.
There are tax-exempt money market funds and bond funds. You also can buy the debt of states and local governments either through a broker or, in some cases, directly from the issuing government.
You’ll earn a lower yield from the tax-exempt debt. The Vanguard tax-exempt money funds recently had yields of around 1.50% or lower, compared to 2.20% or higher on their taxable money funds.
The tax-exempt bond market is not as liquid as the treasury debt market. If you buy individual securities, you probably won’t be able to sell them easily. Individual investors generally shouldn’t buy individual state and local bonds unless they’ve studied the market and work with a broker they know and trust.
Cash had a higher return than stocks and most other assets in 2018 for the first time in a while. Investors who hold cash now have decent options for the first time in years. Consider the options and choose the one that offers the best combination of yield and convenience for you.