By Ben Mattlin
September 26, 2024
https://www.fa-mag.com/news/rates-are-down–time-to-redeploy-your-cash-79695.html

Before the Federal Reserve slashed the benchmark interest rate by 50 basis points in early September, many banks were rewarding clients with yields of more than 4% or even 5% in high-yield savings accounts, money market accounts and certificates of deposit (CDs). According to the Investment Company Institute, retail money market accounts held more than $2.5 trillion before the rate reduction, up from some $1.5 trillion two years earlier.

But what should clients do with their cash now that interest rates are down? RIAs have different opinions on the matter.

One piece of advice is that clients shouldn’t react too quickly or rashly. “Firstly, for all individuals or retirees, it is important to keep some cash at hand for expenses and unexpected emergencies,” said Rafia Hasan, chief investment officer at Perigon Wealth Management in Chicago.

Many banks won’t lower rates immediately, she added, though some already started dropping their yields in anticipation of the Fed’s move. Locking in current rates with a CD may be prudent, but procrastination shouldn’t be too costly either, she noted. “We are still in an attractive yield environment for short-term cash,” she said.

There are still decent options for parking cash, she insisted, though you might have to shop around a little harder for the best place to put it.

At the same time, clients should beware overly generous claims, said Eric Lutton, CIO at Sound Income Strategies in Fort Lauderdale, Fla. “There will be some commission-based firms out there seeking to place these investors into risky ‘high-yield money savings accounts.’ They go by other names as well,” he cautioned. They promise better than 10% returns with FDIC insurance, he said, without explaining how that’s possible. “I’ve seen some backed by illegal gold mining operations in South America,” he said.

Still Some Yield

He recommends that retirees reconsider a traditional source of fixed income: bonds. “There is still some yield to be picked up in fixed-income securities,” he said. “A quality, well-rounded [bond] portfolio should still be able to yield 6.5% or greater without a ton of risk, [and] if an investor is willing to accept a 5.25% yield, their advisor can create a mostly investment-grade portfolio.”

The yield on new Treasury notes will come down along with lower interest rates, he acknowledged, but bond values work inversely to interest rates. As rates come down, the value of many bonds will likely increase as demand rises.

Picking bonds can be risky, though, so he suggests that clients not do it on their own.

Rather than picking individual bonds, many clients will do better with bond funds, said Michael Butterworth of MP Butterworth and Associates, a Reading, Pa.-based unit of Berthel Fisher Companies.

In recent years, as interest rates have moved up, bonds have fallen out of favor, he explained. “As rates rose over the past few years, bond values dropped significantly,” he said. But this is a new market environment. Many of those depressed bond values are now bargains, he said, and since interest rates have fallen, bond values are likely to increase.

He singled out corporate or municipal bond funds with short-to-intermediate maturities as possible good substitutes for cash accounts.

Hasan at Perigon also supports moving some cash funds into bonds—either long-duration government notes or somewhat riskier corporate credits. Holding too much cash, even in high-yield accounts, means missing out on potential longer term returns, she said. But it’s also important, she stressed, to determine how much cash to move and how much to keep for emergencies or specific expenses coming up over the next two years or so.

For long-term growth potential, however, she favors taking on more risk, adding that how much risk depends on each client’s situation.

Equities Still Viable?

For those who are comfortable with the added risk and volatility, equity allocations are still a viable option for long-term positions, she said, despite the market’s record-breaking growth in recent years. Of course, this isn’t a good idea for everyone. “For clients that are currently sitting in cash, the increase in potential volatility of moving from cash to the stock market is a huge leap, especially given that we are in an election year when volatility is elevated,” she said.

The shock of moving some assets out of cash can be mitigated, she said, with a diversified portfolio of both stocks and bonds. This will “help clients manage emotions through this transition” to lower interest rates, she said.

Hardest hit by rate cuts will be retirees, who typically have greater income needs and a shorter investment horizon than working people.

“As Fed rates decline, and with it the income on their cash instruments, retirees are quickly reminded that their income needs extend well beyond the lifespan of the 13-week T-bill that often comprises much of a money market fund,” said Paul Keeton at Prospera Financial Services in Dallas.

For the medium term—somewhere between the long-term growth potential of equities and the short-term cushion of emergency cash—he favors bond or CD ladders. These are portfolios built with securities that have staggered maturity dates to lock in some future income and offset future interest-rate movements.

“Rather than bearing the full risk of a single company’s business line or management acumen,” he said, “the diversification [of ladders] can mitigate that risk and spread it across growth and value companies, or domestic and international markets. Bond ladders can mitigate the duration risk [and] credit risk.”

The laddering of bonds is similar to diversifying an equity portfolio, in that it’s a hedge against having all your eggs in one basket. It spreads risk, advisors say.

Yet it’s a strategy primarily intended for those who need a specific amount of money on a regular schedule, not for clients who want to grow their assets over time, said George Bory, chief investment strategist for fixed income at Allspring Global Investments in New York City. “Bond ladders can work for investors in pretty much any market environment,” he said. “Investors looking to build a portfolio with a very clearly defined pattern of cash flows can use a bond ladder to structure a specific pattern of coupons and maturities over time to meet their objectives.”

Bond ladders have their critics, though. One of them is Chris Tidmore at Vanguard’s Investment Advisory Research Center in Malvern, Pa. Bond funds, he said, provide better liquidity and diversification than bond ladders. What’s more, he said, bond ladders “require reinvestment of proceeds on specific dates. … Transaction costs of buying and selling individual bonds in odd lots are often costly, making a fund superior.”

Nevertheless, maintaining some cash for short-term needs, such as for the payment of an upcoming tax or for unexpected emergencies, remains crucial, he said. “Those needs and the amount [of cash] shouldn’t be affected by the level of interest rates,” he said.