By Gene Balas, CFA®
Money market accounts have been yielding more than they have in years, with 4-week T-Bills and 3-month T-Bills both yielding over 5.3% according to data from Bloomberg, as the Fed raised rates in recent periods to combat high inflation. In tandem, rates on money market funds, CDs, and bank savings accounts have also risen. Even with concerns about the stock market being possibly expensive or even vulnerable to a pullback, why might you consider shifting assets from money market funds, CDS, savings accounts, and cash into stocks or bonds? Such a move can be advantageous for a number of reasons:
1. Historical Interest Rate Cycles:
There have been periods, such as in the early 1980s, when interest rates were significantly high. As inflation was brought under control, rates declined. Those who transitioned into stocks early in the cycle often realized substantial capital gains. For example, after the Federal Reserve’s tight monetary policy peaked with interest rates in the double-digits in the early 1980s, the stock market embarked on a prolonged bull run through the remainder of the decade and into the end of the 1990s. Historically, a decline in interest rates set by the Federal Reserve often led to an increase in stock prices. As borrowing becomes cheaper, it can stimulate economic expansion and improve corporate profits and make stocks more attractive to investors.
Likewise, bonds experienced a multi-decade bull market beginning in the early 1980s, as bond prices rise when interest rates decline. Investors who bought bonds in the early 1980s when interest rates were high – even if not yielding as much as money market funds or CDs – experienced capital gains that offset some potentially-lost income from higher-yielding money market funds. Remember that the reason why longer-term bonds might now yield less than cash is because bond investors expect interest rates to fall over time, as indicated by the Federal Reserve’s forecasts. It is those falling yields that drive capital gains for fixed income investors.
Fed Holds Steady, Signaling Rate Cuts for 2024
Upper limit of the U.S. federal funds target range*
*Dotted lines indicate median projections of the midpoint of the appropriate target rate range at the end of the specified calendar year.
Source: U.S. Federal Reserve
2. Reinvestment Risk:
As the Federal Reserve eventually cuts rates when inflation subsides in coming periods, the yields on money market funds, CDs, and other similar investments then would decrease. The Fed stated its intentions to cut rates when inflation eventually is tamed, meaning that money market, CD, and savings accounts rates in future periods will likely be less than they are now.
3. Long-term Growth Potential:
Historically, stocks have outperformed safer investments like money market funds, CDs, and other cash equivalents over the long term. Remember that investors are compensated for undertaking some degree of risk in the form of potentially higher longer-term returns. One simply needs to decide how much risk to undertake, and which types.
4. Inflation Hedging:
Stocks can act as a hedge against inflation. While a 5% yield on many types of cash equivalents might seem attractive, it may not keep pace with inflation, especially during periods of extensive price increases. Stocks, on the other hand, often provide returns that may outpace inflation over the long run. After all, companies’ revenues (and thus, earnings) tend to rise along with broader price increases in the economy.
Diversification is a key component of risk management in investing. Staying invested in a mix of assets, including stocks and bonds, can help reduce the overall risk of an investment portfolio. One reason why diversification matters is that cash equivalents, including money market accounts, CDs, and savings accounts, yield what prevailing interest rates in the market offer – and those interest rates may decline as inflation recedes or growth concerns prompt the Federal Reserve to cut interest rates.
6. Dividend Income:
Many stocks provide dividend income, which can be an attractive feature for investors, especially those seeking regular income streams. In some cases, the dividend yield of certain stocks can be competitive with the yields from money market funds, CDs, and other cash equivalents. We offer strategies designed specifically to invest in stocks paying high dividend yields; these may be a means of generating income while still offering the potential for capital appreciation.
7. Potential Tax Benefits:
Stocks offer the potential for capital appreciation, which can be a substantial source of returns for stock investors over time. Long term capital gains may be treated more favorably for income tax purposes than investment income, such as interest income from money market funds, CDs, savings accounts, or bonds. (Of course, you will want to share your tax concerns with a tax advisor and your SEIA advisor.)
8. Dollar Cost Averaging as a Compromise Solution:
Using this strategy, an investor would invest their portfolio in stages over time, committing a set dollar amount to be invested on a regular basis. When stock prices are lower, you would thus buy more shares, and fewer shares when prices are more expensive. That way, your average cost per share might be lower than investing all at once (though, of course, you could miss out on any near-term potential appreciation in the market). It also provides a compromise between being either fully invested in stocks right away or remaining all in cash.
It’s important to note that the decision to invest in stocks, bonds, or cash equivalents like money market funds or CDs should be based on your unique investment goals, risk tolerance, and time horizon. If you need these funds for, say, less than 24 months, then perhaps investing in money market funds, short term treasuries, or CDs may be appropriate.
However, if you have a longer time horizon, then perhaps taking on even some risk in a diversified portfolio may be to your advantage. You might consider the following points in determining your investment strategy:
- Take the emotional attachment away from what has worked well the last 24 months.
- Reassess your goals and needs for these assets – what is the purpose for these assets?
- Reassess and reconsider your time horizon for various assets – when do I need these assets?
- Reassess your risk and comfort level – a diversified portfolio with a slight increase in risk may offer a better balance of risk / reward.
Diversification and a well-thought-out investment strategy are crucial in managing risks and achieving long-term financial objectives. Review with your financial advisor your time horizon and investment goals; he or she is an excellent resource to ask questions and receive expert guidance in return.
The information contained herein is for informational purposes only and should not be considered investment advice or a recommendation to buy, hold, or sell any types of securities. Past performance does not guarantee future results. For details on the professional designations displayed herein, including descriptions, minimum requirements, and ongoing education requirements, please visit seia.com/disclosures. Signature Estate & Investment Advisors, LLC (SEIA) is an SEC-registered investment adviser; however, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. Securities offered through Signature Estate Securities, Inc. member FINRA/SIPC. Investment advisory services offered through SEIA, 2121 Avenue of the Stars, Suite 1600, Los Angeles, CA 90067, (310) 712-2323.