Higher interest rates have been a game changer for investors. After years of historically low yields that forced some investors to take more risk to try to generate a little return, yields are now up substantially, and investors are wondering if they need to take risk at all.
As one investor put it, “Why would I need an adviser to tell me where to invest when I can get a 5% yield from a money market fund?”
Should higher yields change your wealth plans?
After 2022’s stock and bond market losses, many investors are attracted to the yields and stability of cash equivalents, especially money market funds, which have greater flexibility and liquidity than certificate of deposits (CDs). However, a good yield isn’t a substitute for a solid wealth plan, and higher yields generally shouldn’t prompt a major change to your plans.
Few people can rely solely on cash to meet their longer-term goals. Cash simply doesn’t have the growth potential of stocks or bonds, and, even in retirement, most people need to try to grow their wealth in order to make their money last and keep up with inflation.
That said, higher yields are an opportunity, especially for money you expect to need sooner than later, so it’s worth considering how to capitalize on that opportunity given your goals, needs, and tax circumstances—and that’s where an adviser can add value.
Remember, advisers do more than help you find good investments; they work to design and implement a comprehensive plan based on your whole financial picture—your investments, taxes, risk tolerance, spending, retirement needs, etc.
Vanguard has studied and sought to quantify how advisers add value to their clients for 20 years now, and its 2022 report concluded that advisers have the potential to add up to 3% to their clients’ returns, largely by helping clients stick with their plans, avoid emotional missteps, and strategically use their retirement accounts in conjunction with their taxable accounts in a tax-efficient way.
5 key questions to answer before you buy into money market funds
With that in mind, here are a few key questions to talk through with your adviser about money market funds:
1. Does cash fit into your long-term plans?
Is a money market fund appropriate for your goals, and if so, where will it fit into your overall asset allocation? How much should you allocate to money market funds, and where should that allocation come from? How does it affect the success of your long-term wealth plan? With some of our wealth management clients, we’ve had deep discussions and shifted a portion of their fixed income allocation into money market funds with the exact cash allocation varying based on different clients’ circumstances.
2. What will you do if yields fall?
Money market yields typically follow the fed funds rate, so yields could fall if the Fed reduces rates later in the year or if there’s a recession. Would this prompt you to move money out of cash, and if so, what would you own instead? We have typically used higher-yielding cash instruments as part of a fixed income allocation rather than part of an equity allocation because if yields eventually peak and start to fall, equities may have recovered by that time, and you’d have missed the chance to buy equities at lower levels.
3. How will higher yields affect your taxes?
Income from money market funds is typically taxable at your ordinary income tax rate, so you’ll want to consider the tax impact, especially if you are close to the top of your tax bracket or this is a higher income year for you (perhaps you’re starting to take required minimum distributions, or RMDs, from your IRA this year). Some money markets generate income that’s exempt from federal or state taxes. Though these municipal funds may have lower yields, many have higher after-tax equivalent yields for those in high brackets.
4. Which money funds are right for you?
There are many money market funds to choose from, including taxable and tax-exempt funds, retail and institutional funds, and funds that own primarily short-term US government debt and prime money market funds that invest in corporate debt. Which fund or funds makes sense for you? Should you own the same fund in taxable and tax-deferred accounts?
5. What about inflation?
Many higher-yielding money market funds and CDs still aren’t keeping up with inflation, which may erode your purchasing power. This is why we believe most people likely need to use money market funds as part of a plan that includes stocks and bonds.
Talk to an adviser about your wealth plans
The takeaway here is that higher interest rates on money markets, CDs, and savings accounts can be useful, but try not to let shiny new yields distract you from the real work that successful investing requires—creating a plan that works for you and that you can stick with through periods of higher and lower yields and returns. If you don’t have a plan or you aren’t feeling confident about your plans, please reach out and let’s see if we can help you get on track.