“At all times, in all markets, in all parts of the world, the tiniest change in rates changes the value of every financial asset.”
Warren Buffet
With the Fed expected to begin cutting interest rates as soon as this fall you may be wondering how to invest your cash while interest rates are falling. After many years of near zero interest rates savers have finally had a few years of safely earning significant interest on their cash. Now that interest rates are expected to fall, it is a good time to look at your cash management options.
Background
After the financial crisis in 2008 the Federal Reserve kept short term interest rates at or near zero for many years in an attempt to stimulate demand in the economy. While this had some positive effects for consumers such as lower home mortgage rates (although the price of most residential housing increased significantly as well!) savers were left without a low risk option to earn interest on their savings.
This financial repression was intended to incentivize spending over saving and investing in risk assets over safer savings options such as savings accounts, CDs, and money-markets.
Fortunately for most of this period inflation was relatively low. That began to change in 2022 as we entered a new inflationary period.
Since then, the Federal Reserve has raised the Federal Funds rate from near zero to a range of 5.25 – 5.5%. This has been a boon to risk-averse savers who have been able to earn meaningful interest on their cash savings. For example, as of this writing Schwab Value Advantage Money Fund (SWVXX) has a 7 day yield of 5.13%. Many short-term bank CDs and online savings accounts are also yielding a similar amount.
This is significant because an investor with a $50,000 one-year CD paying 5% interest can expect to earn $2,500 at maturity vs. almost zero a couple of years ago.
Disclaimer
The economist John Maynard Keynes said, “guessing at the future of interest rates is, in my opinion, one of the most puzzling problems in the world.” No one can predict future interest rates. Even the Federal Reserve members themselves have a difficult time forecasting rates. I do not recommend speculating on future interest rate changes.
However, it is wise to have a strategy for investing your cash while interest rates are falling.
Options For Investing Your Cash While Interest Rates are Falling
Prioritize Safety and Liquidity
One option is simply to maintain your current strategy. The advantage of this is that most other strategies will either sacrifice liquidity or safety of principal. If having your cash liquid (available within a day or two) and protecting the principal of the investment are your main priorities then sticking with your money market fund or online high yield savings account make sense.
The disadvantage of this strategy in a falling interest rate environment is that the interest yield will likely decline in real time (or with a slight lag) along with changes in the Fed Funds rate.
If the Fed does not reduce interest rates, or if interest rates are increased in the near term (this seems unlikely but because we cannot predict interest rates it is certainly possible!) you would also be in good shape with this strategy.
Extend the duration of your cash savings
Another option for investing your cash while interest rates fall is to lock in today’s rates by extending the duration of your cash. If you do not expect to need your cash savings (or a portion of your cash savings) for the next say 6 or 12 months you may benefit from a longer duration option.
Certificates Of Deposit
The simplest and safest option for an individual investor is an FDIC insured bank Certificate of Deposit (CD). With a CD you are allowing the bank to lock up your funds for a defined period of time in exchange for a defined interest rate. For example, consider a bank offering a 6 month 4.5% Certificate of Deposit. The 6 months is the time your funds are locked up and the 4.5% is the annualized interest rate paid on the deposit. If you invested $10,000 in this CD, at the end of the term you would receive your $10,000 back plus $225 (six months worth of the annual interest assuming no compounding).
With a CD you don’t mind if interest rates are falling because your yield is locked in for the term. Of course, if yields on money markets or online savings accounts rise during the term you would have been better off sticking with them.
Make sure to shop around for rates and terms. Don’t overlook local and regional banks as they may offer better deals than the large national banks. FDIC insurance is generally available up to $250,000 per account owner.
Treasury Bills
If you have significant cash to invest over the FDIC insurance limits of $250,000 and/or you would like more liquidity another option to consider are United States Treasury Bills. These instruments will also lock in yield for a specific term. However, unlike a bank CD they are not FDIC insured and can be sold at any time during the term.
The price will fluctuate based on current yields, so if you sell early during a falling interest rate environment the price may be lower than your initial investment. If you hold for the term you will receive your principal and interest back subject to the full faith and credit of the US government.
Treasury bills can be purchased through your broker (Schwab, Fidelity, Vanguard, etc.). You can also purchase treasuries directly from the federal government at treasurydirect.gov.
I bonds/Savings Bonds
Another option for individual savers are US savings bonds. I Bonds will even adjust based on inflation. These are intended to be longer term instruments than the other two options and have their unique advantages and disadvantages. I have written extensively about I Bonds here.
Take on more risk
A third option would be to use this time to re-evaluate your overall asset allocation. Many investors have been holding longer term investment funds in cash for the past few years rather than investing in risk assets such as stocks, bonds, and alternatives. Why take the risk of the stock market when I can get a safe 5% on my cash?
With the possibility of entering a time of falling interest rates now may be a good time to determine how much of your cash is truly a short term cash reserve and how much of your cash would be better deployed into longer term risk investments such as stocks and bonds.
Historically, cash has earned a significantly lower total return compared to bonds and especially stocks, often barely keeping up with the rate of inflation.
Deciding upon how much to allocate between stocks, bonds, cash, and alternatives should be done in the context of a financial plan either done yourself or with the help of a professional financial planner.
