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What to Do with Cash in a Low Yield Environment

“What’s a good replacement for income from a CD or a money-market fund?” an investor asked us. “Are bonds the best way to do that? I can’t afford to take any risk.”

CDs and money-market funds have been paying anemic rates for years, and with interest rates so low, even short-term bond funds, one of the safest areas of the bond market, aren’t yielding much either.

So where should you park your cash these days? The answer depends on why you’re keeping money in cash in the first place.

At FundX, we work with our wealth management clients to determine why their money is in cash, what that money is intended for, and when they expect to need it. From there we can consider how this money fits into their overall investment plan.

3 common uses for cash

Here are three common uses for cash and some of FundX investment advisors' ideas on what to do with it.

1. Short-term expenses and emergency reserves

You won’t want to take much risk with money that you’ll need on demand. A money market fund is liquid and low risk, but it’s not risk-free. With such low yields, it likely won’t keep up with inflation, but you may find that it’s a small price to pay to ensure that your money is there when you need it.

High-yield online savings accounts may be your best bet for money you’ll need sooner than later. Online banks tend to yield much more than traditional banks or money market funds, since the banks that offer these accounts are virtual and have lower overhead costs. These online banks are FDIC insured, just like your brick-and-mortar checking/savings account, with certain limits.

Depending on your situation, part of these reserves can also be invested in fixed income for generating higher returns. Short-term bond funds can also be appropriate here, however, they are investments that can lose value as happened in the March 2020 market disruption.

2. A cushion for stock declines

You might be tempted to keep some cash on the sidelines as a way to cushion stock market declines, but cash usually isn’t a good substitute for bonds as the fixed income instrument of choice in your overall asset allocation.

Bonds with longer maturities (as compared with CDs or ultra-short term bonds) can offer yields that might keep up with inflation. Cash, on the other hand, inevitably loses value over time to inflation.

Plus bonds have historically been better able to buffer the volatility of stocks because bonds generally rise when stocks fall. This is why a portfolio of both stocks and bonds may hold up better in market declines than a portfolio of stocks and cash.

3. Future investments

If you have extra cash in your accounts right now that you’re looking to invest when the time is right, make sure you have a plan that can help you put your cash to work so you don’t end up in cash indefinitely. 

We often hear from investors who thought they’d be out of the market for a few months but they ended up in cash for years trying to find the right time or the optimal fund to own. This can be a serious drag on your returns.

If you’re worried about a stock market decline and you can afford to take less risk and still reach your goals, then you might start by investing in more conservative investments.

Try to avoid the temptation to buy into riskier funds in an attempt to make up for lost time. If the market sours and your investments fall sharply, you could end up back in cash again. Instead, focus on getting invested in a way that can keep you invested, even if markets change.

Cash is part of your financial plan

Financial planning can help you determine how much money you should keep in cash based on your financial situation and how you should invest for mid-term and long-term goals. Some of our wealth management clients can afford to keep a larger cash allocation for peace of mind, while others need to be more fully invested.

As part of our financial planning process, we recommend a bucket approach that assigns goals and investment objectives to specific allocations of your portfolio. This helps determine how much to save and where to invest these assets over time. This structure develops into your overall financial plan and investment strategy as you look to fund your various short-, mid- and long-term spending goals.

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