Investment

Beyond money markets: Maximizing your cash

Beyond money markets: Maximizing your cash
Key takeaways
Lower real return
1

After factoring in inflation and taxes, the real return of a money market is much lower than investors may expect.

Lower long-term performance
2

Longer-term government bonds, corporate bonds, and stocks have historically returned more than cash.

Reinvestment risk
3

One of the risks of short-term investing is not being able to reinvest the money at the same rate.

While it may seem like a no-brainer to stash cash in money markets right now because of their relatively high interest rates and low risk, it may not be as risk-free as investors think. Yes, there can be such a thing as too much cash. Choosing money markets over investments with more growth potential can impact long-term portfolio performance. Corporate bonds, core bonds, and stocks — and the funds that invest in them — may be better long-term options for some of this money, in my opinion. Here are three reasons why.

(For a deeper dive, see my chartbook Beyond money markets: Maximizing cash.)

1. Lower “real” return
When you figure in inflation and taxes, the income generated by money markets is less enticing. Consider this hypothetical example: $100,000 invested in a money market yielding 5.05% would earn $5,005 in interest a year. When factoring in 4.7% inflation and a 37% income tax rate, the real return on the investment is actually a loss of $1,547.1

2. Lower return over time
Short-term cash-like investments have historically generated significantly lower return than longer-term government bonds, corporate bonds, and stocks, as the example below shows. Yes, cash-like investments may outperform Treasuries over short time periods, but using the same 30-year time period as the example below, U.S. Treasuries outperformed cash during 98% of the rolling monthly 10-year periods during the past 30 years.2

Cash has a significantly lower return over the long term

Sources: Bloomberg L.P., 12/31/22. Large-cap stocks are represented by the S&P 500 Index, including dividends. High yield bonds are represented by Bloomberg US Corporate High Yield Bond Index. Corporate bonds are represented by Bloomberg US Corporate Bond Index. Government bonds are represented by the Bloomberg US Treasury Index. Cash-like instruments are represented by the S&P US Treasury Index 0-1 Year Index. Inflation is represented by the Consumer Price Index. The chart features hypothetical examples, which are shown for illustrative purposes only, and do not predict or depict the performance of any investment. An investment cannot be made directly into an index. Past performance does not guarantee future results.

3. Locking in long-term rates may be better 
Reinvestment risk is among the biggest challenges of investing in short-term securities, such as money markets, because that money generally has to be reinvested every few months. At some point, interest rates will fall from today’s elevated levels, and the money market will have to reinvest in lower-yielding securities. Investors who like today’s yields may be better off locking them in for the longer term with bonds.

How might investors move out of cash?

Let’s look at three instances when cash balances were high — following the 1991 and 2002 recessions, the 2008 Global Financial Crisis, and the 2009 European debt crisis — and calculate what $12,000 invested yearly in the stock market for 10 years would have been worth. Since there are many ways to put cash back to work, I considered four investing scenarios:

  1. Perfect timing assumes that an investor maximized their return in the S&P 500® Index each year.
  2. Worst timing assumes that an investor minimized their return in the S&P 500 Index each year.
  3. First of the year imagines an investor moving the entire $12,000 into stocks as a lump sum at the start of each year.
  4. Dollar cost averaging assumes an investor made a $1,000 per month investment in the index yearly.

I compared each of these strategies with the returns an investor would have if they simply continued to hold cash (calculated using the Bloomberg 1- 3 Month US Treasury Index).

 

Investors have been better off investing their money versus holding cash

Sources: Bloomberg L.P., Invesco, 12/31/22. Assumes $12,000 invested yearly into a hypothetical S&P 500 Index portfolio. Cash return is based on return of $12,000 invested yearly in a hypothetical portfolio of 3-month Treasury bonds represented by the Bloomberg 1-3 Month US Treasury Index. Perfect timing (worst timing) assumes that you maximize (minimize) your return in the S&P 500 Index each year. Dollar cost averaging assumes a $1,000 per month investment in the S&P 500 Index yearly. For illustrative purposes only and not meant to depict or predict the performance of any strategies. Indexes cannot be purchased directly by investors. Past performance does not guarantee future results.

In each instance, investors would have been better off investing their money in stocks versus holding cash — regardless of how they did it. Investing a lump sum at the first of the year and dollar cost averaging were both sound strategies. While all investors would like perfect timing, even having the worst timing each year still outperformed cash.

Footnotes

  • 1

    Sources: Bloomberg L.P. and Bankate.com, 7/31/23.. Income is calculated using the interest rate on high yield money market accounts for investments of $50,000 or more from Bankrate.com. Based on the money market rate on 7/31/23 and the average of the year-over-year percent change in the US Consumer Price Index for the first seven months of the year.. The Consumer Price Index (CPI) measures change in consumer prices as determined by the U.S. Bureau of Labor Statistics. Hypothetical tax rate in the chart is 37%. The 4.3% Affordable Care Act surcharge was not included. Tax rates and brackets are subject to change. Changes in tax rates and tax treatment of investment earnings may affect the results shown. Investors should consult a tax advisor. An investment cannot be made directly into an index. Past performance does not guarantee future results.

  • 2

    Source: Bloomberg, L.P., 1992 through 2022. Cash-like instruments are represented by the S&P US Treasury Index 0-1 Year Index, which is designed to measure the performance of U.S. Treasury bonds maturing in 0 to 1 years.