Money-Market Funds and CDs: What Investors Need to Know

Individual investors are increasingly turning to cash-equivalent investments such as money-market funds and certificates of deposit, which are yielding 5% or more, to hedge against the possibility of a recession later in the year. 

‍

Despite these investments offering low-risk returns, investors should also have a long-term cash strategy that considers financial goals, risk tolerance, and anticipated expenses.

‍

Andy Smith, executive director of financial planning at Edelman Financial Engines, warns that investors should not be solely lured by the higher rates of these products, but instead should balance their portfolios with a broad cross-section of stocks, bonds, real estate, commodities, and other alternative asset classes to manage risk during volatile times. 

‍

He recommends cash or cash equivalents represent only a small percentage of an individual's asset allocation, often ranging from 5% to 10%, depending on their goals and risk tolerance.

‍

Investors should also be aware that putting too much of their portfolio in cash is a strategy that can backfire and be a drag on portfolio performance. According to Angelo Kourkafas, senior investment strategist at Edward Jones, “Cash has outperformed both stocks and bonds only 12 times over the course of a year since 1929. Last year was one of those times."

‍

Stocks and Bonds and Cash, ‘Oh My!’

Since 1928 cash has outperformed both stocks and bonds over the course of a calendar year 12 times (just 13% of all instances). The only three times that cash was positive while both stocks and bonds were negative was in 1931, 1969 and 2022.

Money-market funds have become increasingly popular with individual investors, with over $488 billion flowing into them this year through April 27, according to Crane Data.

‍

 These funds invest in short-term debt instruments such as U.S. Treasury bills and are considered “cash equivalents,” offering investors liquidity with extremely low levels of risk. 

‍

However, investors should be aware that these funds aim to maintain a net asset value of $1 a share and should consider looking at the seven-day SEC yield, which is the standard measure of performance for money funds, when assessing these funds.

‍

The Federal Reserve's actions on interest rates in the months ahead are another market variable that investors must consider. 

‍

If the Fed decides to cut interest rates instead of raising them, yields on CDs and other cash-equivalent instruments may decline, while equities rebound. Investors should weigh the trade-offs and make informed decisions accordingly.

‍