Cash is cool. Interest rates on money market funds are well over 5%. The 3-month U.S. Treasury Bill yield is 5.5%. According to Google, the only time “money market” has been a more popular search term than earlier this year was during the depths of the global financial crisis in 2008.

The chart below shows historical short-term rates, which were anchored near 0% for most of the 2010s. Yields haven’t been this attractive in over 20 years.

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Investors are certainly taking notice! According to data from Morningstar, assets in money market funds are at all-time highs, nearing $5.5 trillion. At the same time, bank deposits have been falling, as savers look to earn higher yields on their cash.

Some people have asked if they should be investing in stocks or other asset classes when they can safely earn 5%. Here are a few things to consider when trying to answer that question.

Potential money market PROs :

SAFETY. Money market funds and U.S. Treasury securities are considered some of the most secure investments you could own. Research has shown losses hurt more than gains feel good. This phenomenon is termed prospect theory in behavioral finance. Investors who are primarily concerned with return of principal, not return on principal, will likely find these types of investments attractive, regardless of the interest rate.

LIQUIDITY. In addition to safety, there’s a reason these types of investments are commonly used for emergency funds. U.S. Treasury securities are among the most liquid in the world. Money market funds typically come in a couple flavors – those that invest in government securities only, and those that will also include debt from other corporate borrowers. Regardless, they are designed to offer a great deal of liquidity and stability to their investors.

POSITIVE “REAL” YIELD. FOR NOW. Inflation has been cooling off in recent months, falling from 9% last summer to about 3% at the end of July. And with short-term yields over 5%, investors are earning “real” return of over 2%. Real returns are simply the returns after considering inflation. One of the most basic reasons for investing is to protect purchasing power.

Potential money market CONs:

DECISIONS, DECISIONS. Many of the questions we hear start like this: “Is it a good time to…?” For better or worse, we (meaning people in general) often make decisions that are emotionally driven. We may learn that 2023 was an exceptional opportunity to be in cash alternatives like money market funds. But we think there could be a better way to make these types of allocation decisions over the long run. Having a plan that outlines where you want to be, when you hope to get there, and how you plan to do it can help reduce the urges to make emotional decisions with your money. Reducing the number of decision points, we believe, can help minimize mistakes that could throw your plan off track.

TAXES. The interest received from money market funds is typically considered ordinary income. For high income individuals and families, that could account for 40% or more of your return. Imagine a family with $500,000 in money market funds, earning 5.2%. The result is $26,000 in ordinary income, which could increase federal and state income tax liability by $10,000 or more.

PURCHASING POWER. Back to “real” yields. To repeat from above, one of the primary reasons for investing is to protect purchasing power. We want to make sure our quality of life isn’t hurt by rising prices. Inflation took center stage in 2022 and is still running above the Fed’s 2% target. While cash alternatives currently offer a positive real yield (the ~2% difference between money market yields and inflation), the long-term history is more mixed. Using short-term Treasury Bills as our proxy, U.S. investors earned a real return of 0.9% in bills last century, and real yields appear particularly high during the 1980s and 1990s. (Source: Triumph of the Optimists, Dimson, Marsh, and Staunton) For much of the last 20 years, and particularly during the 2010s, cash actually lost real value due to inflation. Cash and cash alternatives can play an important role, but other ownership-type investments like stocks have historically done a much better job of protecting and growing purchasing power over time.

Interested in talking more about the role money market could play? Schedule a call with the team below.

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