Choices for Investing Cash

With potential interest rate cuts on the horizon, many are rethinking their short-term investment strategy for cash. Short-term U.S. Treasury bonds might be worth exploring in this evolving economic climate.

Money Market Funds: An Easy Choice

Offered by most brokerage institutions, money market funds are comprised of many ultra-short-term (30-40 days), low-risk investments that various government agencies or corporations typically issue. They offer several positive attributes, including quick access to your money, making them ideal for everyday expenses or emergency funds. You can easily withdraw these funds without penalty, unlike other investments.

Additionally, compared to traditional checking accounts, money market funds potentially offer higher yields, allowing your cash to grow slightly faster. Currently, many money market funds yield between 5% and 5.25%.

However, while money market funds provide investors a way to earn money on their cash, as many banks keep their rates at or near zero, there are a few drawbacks. The yields on money market funds depend highly on the Federal Reserve and its decisions about interest rates.

While this variability of yields allows investors to benefit quickly when interest rates are rising, it can hurt investors when interest rates fall. Money market funds are susceptible to the Fed cutting interest rates because their yields are not locked in for any meaningful length of time and can quickly fall if rates are cut.

Short-Term Treasury Bonds: Advantages and Considerations

Compared to money market funds, investing directly in short-term Treasury bonds could benefit investors in this environment. Backed by the full faith and credit of the U.S. government, Treasury bonds offer exceptional security. Short of a default of the federal government, owners of Treasury bonds will receive their principal investment back plus interest if held to maturity. This makes them a very safe option, along with money market funds.

Unlike money market funds, however, Treasury bonds offer a set interest rate at purchase for a pre-determined time. Short-term Treasury bonds are offered with durations in three-month increments. Currently, yields range from ~5.4% for a 3-month Treasury to ~5.1% for a 1-year Treasury. This provides investors stability of returns because they can lock in their rate for a pre-determined period of time, reducing potential concerns about lower returns if interest rates decline.

Additionally, the interest earned when you own Treasury bonds directly is exempt from state and local income taxes. This boosts your overall after-tax return compared to money market funds, especially if you live in an area with high local taxes.

There are a few considerations to keep in mind when purchasing Treasury bonds. First, making the purchase can be a bit more complicated than simply using a money market fund if you are not familiar with using your custodian’s trading platform.

More importantly, unlike money market funds, the value of Treasury bonds fluctuates daily and requires holding them until maturity to receive the full interest rate. To access your money before maturity, you would need to sell them on the secondary market, which could result in lower returns than were anticipated or even a loss if interest rates rise after your purchase.

Conclusion

Both money market funds and Treasury bonds are viable options for your short-term investment allocation. It’s important to ensure that whatever you choose aligns with your time horizon and liquidity needs. Treasury bonds might be a good fit if you prioritize safety and are comfortable with limited liquidity. However, if immediate access to your money is crucial, a money market fund might be preferable. Finally, remember that neither money market funds nor Treasury bonds are FDIC-insured and are therefore subject to loss. For personalized guidance tailored to your unique circumstance, consult your financial advisor.

About Us | Get the Bedel Blog | More Cash Articles