For the past couple of years interest rates have been climbing or have remained at elevated levels. This has made CDs and money market funds very attractive investments. Now that the Federal Reserve is lowering interest rates, and CDs and money market funds are paying much less interest, where should I park all my cash in order to get a decent return while not risking my principle? – Anonymous
This is the question of the hour as many investors ponder where to keep their cash as the yield on “cash equivalents” like CDs, money market funds, and T-Bills is dropping meaningfully. As of this writing, we are well below the 5% yields that investors enjoyed throughout most of 2024. The good news is that in every market environment there are opportunities. To determine how best to allocate your funds, it’s important to understand your personal financial goals. Let’s explore a few areas to help answer your question:
What is the purpose of cash: Maintaining a sufficient level of cash helps families pay their routine bills and provides a cushion in case of an unexpected expense (e.g. leaky roof, flat tire, medical emergency, etc.).
It’s also important to have enough cash for any short-term large financial outlays. This may include upcoming yeshiva tuition bills, a bar mitzvah, down payment for a house, purchasing a new car, or a vacation.
How much cash should you have on hand: The rule of thumb is to maintain 3 to 6 months’ worth of expense money in cash. If you anticipate a large purchase coming up, then keeping additional cash readily accessible to cover that cost is also important. The key is to strike the right balance. Have enough on hand to pay short-term expenses plus a cushion to provide peace of mind to help you sleep at night, without maintaining too much cash, which is a significant liability.
The fallacy of “risking principle”: Oftentimes, friends will tell me that they like to keep their funds in cash equivalents so they “don’t risk losing their principle.” This phrase shows a lack of understanding of risk and how it impacts our lives. It’s important to keep in mind that any money that is kept in cash equivalents for too long will inevitably end up losing buying power in the future.
While the dollar amount appears to slowly increase every year, it is not rising as quickly as “inflation,” or the increase in the prices of goods and services over time. While we experienced a spike in inflation over the past few years, briefly touching over 9%, the long-term rate of inflation ranges between 2% and 3% annually. The cost of some items, like housing, food, or gasoline, may rise much faster. Over an extended period of time, cash equivalents will yield lower than that on average. Therefore, if you intend on saving money for your future, keeping it in cash equivalents, which underperform the rate of inflation, will ensure that you can buy less goods and services with your dollars. Maintaining a level of cash beyond the threshold for your short-term expenses and emergency fund will be a catastrophic mistake.
Your time horizon is key: Ultimately, when you will need your money should determine where to put it.
Cash equivalents: As I’ve mentioned, this category is appropriate for short-term expenses. Items anticipated over the next 3 to 6 months, or possibly a bit longer if you have a significant upcoming expense. Even as rates continue to drop, you don’t want to risk short-term funds in other investments. The key is having the liquidity when you need it. Over the past two years, investors had a wonderful gift of 5%+ yields on their cash. However, I’d caution any investor who spends time shopping for the highest available return. That should not be a priority for these funds, the key is simply to keep them in a place that is easily accessible and liquid so you have it when you need it.
Bonds: Bonds are a loan, where an investor lends money to a company or government in exchange for interest payments and the return of the original loan amount. They typically offer lower returns than stocks, but higher returns than cash equivalents. Bonds are useful in achieving intermediate goals since they help diversify a portfolio and reduce investment risk. If you have a goal that is less than 10 years down the road, bonds should undoubtedly be a component of your investment strategy. However, if you won’t need your money for decades, then a portfolio mostly in bonds is not the right approach.
Stocks: Stocks are the ultimate investment for long-term portfolio growth. Stocks are a type of security that represent ownership in a company. They are a claim on the company’s assets and earnings, and the value of the stock rises and falls with the value of the business. If you’d like your portfolio to grow over the long-term and outpace inflation, stocks should be a significant portion of your holdings. Any investor with a 10-year or longer time horizon is doing themselves a major disservice if they don’t own enough stocks.
What should you do? Since this is The Jewish Press, it makes sense to answer your question with another question: What are you looking to accomplish with your money? Your answer will determine when you need the money and lead you to the correct decision. For example, if you are paying for a large simcha this year, then staying in cash, a money market fund, or short-term CDs is the correct decision regardless of falling yields. After all, you need that money readily accessible and can’t risk fluctuation. On the other hand, if you plan to put a down payment on a second home in Israel within the next 5 to 10 years, then a diversified portfolio of stocks and bonds may be the prudent approach to grow your money while mitigating volatility. Finally, if this is money you don’t plan to touch for a decade or more, or it’s money you’d like to leave to your kids or grandchildren several decades down the road, then a portfolio that includes primarily stocks is sensible. It will allow you to grow your nest egg and outpace inflation. Getting lured into a false sense of security by maintaining too much cash will have a devastating impact on your finances as inflation erodes its value over time. It will also lead to having a much smaller nest egg in retirement and leaving less money to loved ones.
As I frequently tell my clients and readers: “Personal finance is personal.” There is no one right answer for how to allocate your funds. Each investor must determine their specific goals, time horizon, and appetite for risk which will allow them to craft a strategy to help achieve those objectives. This answer may not be satisfying, but hopefully the aforementioned framework will help you make the right decision.
