The siren song for money market funds has gotten a little louder. Cash yields remain high for now, with the timing of the Federal Reserve’s interest rate cuts in doubt. After central bank policymakers stressed last week that there was a “lack of further progress” in curbing inflation, Wall Street differed widely in their expectations for the number of interest rate cuts in 2024, ranging from a minimum of one to a maximum of four. I responded as expected. It also means, at least in the short term, that investors who stash cash are well compensated for doing so. The Crane 100 Money Fund Index had a seven-day annualized yield of 5.13% as of May 8th. Financial offers his one-year certificate of deposit at 5.25% per annum. But those who keep too much money in these cash reserves risk missing out on the expected rise in bond prices once the Fed starts lowering interest rates. “If the Fed cuts rates, yields on money market accounts will fall quickly,” said Rob Williams, managing director of financial planning at Charles Schwab. Here’s how to decide when and where to reallocate some of your idle cash to bonds. Gut Check A general rule of thumb in financial planning is to have at least one year’s worth of expenses in readily available cash, but if you plan on spending more than that, consider your goals and portfolio asset allocation. need to be reviewed. Ashton Lawrence, a certified financial planner and senior wealth advisor at Mariner Wealth Advisors in Greenville, South Carolina, says, “Where you put your first dollar depends on what you want to accomplish. That’s what it means,” he says. “What people should consider, no matter what they’re investing in, is how sensitive the next dollar will be to interest rates.” He said key factors to consider include interest rate sensitivity, credit risk and liquidity. Duration (the sensitivity of a bond to changes in interest rates) is also a focus. Bonds with longer maturities tend to have longer durations, but when interest rates change, their prices can change the most than bonds with shorter durations. Diversification is also important. “Spread your fixed income investments across different sectors and different maturities, such as government, corporate, and municipal bonds,” Lawrence said. Taxes are also an important consideration when expanding your fixed income bracket. Interest received on corporate bonds, CDs, and money market funds is subject to ordinary income taxes, which can be up to 37% depending on your tax bracket. Interest income from the Treasury, on the other hand, is subject to federal income tax but exempt from state and local taxes. Municipal bonds provide tax-free income at the federal level and may also be exempt from state taxes if the investor resides in the issuing state. This savings is especially important for high-income investors in high-tax states like New York, New Jersey, and California. The tax treatment of a fixed income investment will also ultimately be a factor in the account’s holding of the asset. For example, corporate bonds and the funds that hold them can be good candidates for tax-deferred accounts, while municipal bonds don’t need to be protected from taxes and are better suited for tax-brokered accounts. “Muni’s shorter maturities and higher ratings in tax intermediaries are favorable for investors in higher tax brackets,” Williams said. Gradual Entry to Bonds He doesn’t have to build his bond allocation in one day. For investors starting to get used to the idea of adding duration, the CD or Treasury bill ladder may be a good first step, Williams said. These ladders involve purchasing a portfolio of fixed income investments of varying maturities, and then, as those assets mature, the proceeds can be reinvested into longer-term instruments. You can also dollar-cost average your bonds and build those positions incrementally. “This could include saying, ‘Every month, every quarter, every year, I’m going to increase my allocation to fixed income by this amount,'” Williams said. Dollar-cost averaging into diversified mutual funds and ETFs allows investors to easily access bonds rather than buying individual bonds. Lawrence likes the idea of using individual bonds to build a bond sleeve because investors who hold them to maturity don’t have to worry as much about price fluctuations in between. But for those leaning toward bond funds, he prefers active management over passive management. “Mutual funds are an efficient way to diversify, but I would prefer active management,” he said. “Active managers can strip out the ugly parts of the index and outperform in that regard.”
Money market funds with yields above 5% won’t last long.where to put leftover cash
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