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Savers and investors have rekindled their relationship with cash, which offered steadily rising yields as interest rates climbed in 2022 and 2023.
But in 2024, some of the thrill might be gone.
The Federal Reserve is holding its key interest rate at a two-decade high, and officials at the central bank have penciled in three rate cuts next year.
Stock markets — already rallying on the wager that the Fed is finished with its program of hiking rates to quell inflation — loved the news. The Dow Jones Industrial Average
DJIA
had three straight record closes in the days following the Fed’s rate decision.
The latest decision is more fodder for the relationship advice Matt Sommer at Janus Henderson Investors has been offering clients — their relationship with cash, that is. “It’s OK to date cash, but you don’t want to marry cash,” said Sommer, who heads the specialist consulting group at the company.
Looking to 2024, “the playbook changes quite dramatically,” Sommer said. In his view, cash and cash equivalents — such as high-yield savings accounts, bank CDs, money-market mutual funds and short-term Treasury debt — will shift “back to the original, most traditional use case” of serving as vehicles for rainy-day savings and liquidity needs.
Meanwhile, longer-duration bonds gain appeal, Sommer noted. “Now is the time to begin to re-enter more traditional fixed-income investments,” he said. There’s the chance of higher yields now, compared with newly issued bonds in the near future, he said. There’s also the chance these bonds will gain value as interest rates eventually decline, he added.
Some of the clients working with financial adviser Liam Timmons have found it comfortable to be heavier in cash, but he’s nudging them to move out of their comfort zone. “You don’t really get growth with cash. If you’re lucky, you keep pace with inflation,” said Timmons, president of Timmons Wealth Management in Attleboro, Mass.
For now, it’s easy to find high-yield saving accounts above 4%, and even rates above 5% are common on one-year CDs and in the seven-day yields for money-market funds. At the same time, November’s inflation data showed a year-over-year decrease to 3.1% from 3.2%.
It’s a brief moment, Timmons said. When managing clients’ cash, he uses a combination of money-market funds, CD ladders, short-term Treasurys and high-grade short-term corporate debt. “However, money that is not needed in the near term is likely better allocated to a combination of intermediate-term bonds and a diversified portfolio of stocks,” he said.
People trimmed the cash allocation in their portfolios to nearly 19% in November, according to the American Association of Individual Investors. That’s a 0.77% decrease month over month and is down from 24% a year ago.
No one is saying people should break up with cash, however. For Sommer, it’s more like acknowledging a good run but taking some space. “There’s always a place for cash,” he said.
Like so much else with near- and long-term money management, the degree of cash exposure hinges on personal needs, risks and goals, according to James Martielli, head of investment and trading services at Vanguard.
By the end of 2024, the Fed’s rate could fall to 3.5%-4% from the current 5.25%-5.50%, according to a Vanguard outlook on 2024. Wherever rates land in the coming years, it will not be a return to the way it was. “Zero interest rates are yesterday’s news,” the outlook from the wealth-management giant said.
Here’s what to know for 2024.
Bank accounts and CDs
The Fed pause is reflected in savings accounts and CDs. The annual percentage yield for online savings accounts has averaged around 4.4% since September, and the APY for an online bank’s one-year CD has averaged around 5.3% since November, according to DepositAccounts.com.
Banks can trim their rates before the Fed starts cutting, said Ken Tumin, founder of the site. By the time the Fed cut its rate in July 2019 — the first cut since 2008 — the average APYs for bank accounts had fallen 7 basis points from a recent peak, Tumin noted, and there was already a drop of more than 30 basis points for one-year CDs. A basis point is 1/100 of one percentage point.
“When the writing is on the wall, you’ll see the banks respond,” Tumin said. “Generally, when they see the signs rates are coming down, they don’t wait.”
A five-year CD has been stuck around a 3.9% average for most of the year, Tumin noted. The rates on CDs lasting at least three years “will be falling the fastest, as they are more tied to economy.”
Of course, falling rates do not erase the need for savings accounts and CDs. In fact, it could prompt another hard look at one-year CDs now to lock in a rate of over 5%, he said.
CDs always serve a distinct purpose, said Isabel Barrow, director of financial planning at Edelman Financial Engines.
“If you have a defined need, such as a big tuition payment that is due on a specific date, a CD might be your best bet to get the highest possible interest,” she said. “Shop around — there is a big range of interest rates being offered.”
Money-market funds
These mutual funds include short-term Treasury debt, other government debt and their yields, which hinge closely on the Fed’s benchmark rate.
They’ve been stuffed with cash as the rate hikes continued. Through mid-December, the funds for retail and institutional investors totaled a combined $5.89 trillion, according to the Investment Company Institute, an association representing regulated investment funds. That’s up from roughly $4.5 trillion in March 2022, when the Fed started its rate-hike campaign, according to ICI data.
The seven-day yield on the 100 biggest money-market funds averages 5.18%, according to Crane Data.
“With yields topping 5%, money-market funds are an attractive option for retail investors and are likely to remain so through next year,” said Shelly Antoniewicz, deputy chief economist at the ICI.
“Even if the Fed starts easing monetary policy in 2024, these policy moves are likely to be carefully considered and more measured as the Fed works to bring inflation back to its 2% target,” she said.
The close tie between the Fed rate and money markets will become evident quickly as rates decline, Sommer said. It’s been nice on the way up, but unlike a CD, there’s no guaranteed yield on the way down. “With money markets, you’re not locked into anything,” he said.
Treasury bills
Treasury bills, which come due within a year, have also gained prominence as the Fed hiked rates. Three– and six-month Treasurys have offered yields above 5% for most of 2023, which is pretty nice. Plus, the interest income from Treasury bills, as with other Treasurys, is exempt from state and local income taxes.
But what happens when these short-term bills come due? Research suggests that what goes up must come down, at least if the 10-year Treasury note provides any clue. The yield on the 10-year has fallen in the months preceding Fed rate cuts since the 1970s, according to Ned Davis Research.
Longer-duration bonds purchased now give investors two good options if rates fall, Sommer said. There’s a chance to lock in a higher yield now and there’s the chance of price appreciation on the face value of the bond. That’s because bond prices tend to increase when interest rates fall.
“Bond funds, in a broadly diversified portfolio, are that ballast that helps smooth out volatility in riskier assets,” Vanguard’s Martielli said. Indeed, the case for a classic 60/40 portfolio split of stocks and bonds is getting stronger in 2024, Vanguard said.
See also: Fed could be the Grinch who ‘stole’ cash earning 5%. What a Powell pivot means for investors.
What cash investors could miss out on
The big argument against getting too heavily into cash relates to what an investor potentially misses out on in the stock market. One analysis found that stock returns have trounced cash yields in economic cycles going back decades.
Cash offers clear upsides like liquidity, flexibility and “negligible” investment risk, said Andy Smith, executive director of financial planning at Edelman Financial Engines.
But beware the downsides of too much cash, he added.
“If you’re holding cash because you’re trying to time the market, you have to pick the right moment to get back in — in addition to you picking that one magical moment to get out of the market,” he said.
Trying to predict and time market events is highly difficult and could cost you, Smith noted. Here’s a chart showing Edelman Financial Engines’ research on the issue:
“If you’re holding cash because you’re trying to time the market, you could be missing out on the handful of great days that make a year’s return,” Smith said.
To circle back to the relationship-advice analogy, those great days are like the ones that got away.
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