As interest rates have risen, so have yields on ‘safer’ investment options, such as bank deposits and ultra-short-term Treasuries (T-bills). An investor can easily pick up a 5% yield with minimal risk.
Money market funds are yielding, on average, 1.5%. CDs rates are somewhere between 1.4% and 5.15%, depending upon its maturity. High-yield savings accounts have rates as high as 5%.
Not surprisingly, many investors have been wondering lately-
“If the stock and bond markets continue to be volatile, shouldn’t I just put my money into these safer investments? Why should I continue to risk my principal?“
This is a valid question. An investor should definitely take advantage of these higher rates. In fact, we have already done this within all of our portfolios. For example, our Moderate portfolio currently holds 19% of its portfolio in T-bills, which currently yields 5.4%. This is an attractive rate with minimal risk. But this move is calculated and not one we intend to hold onto forever, which we discuss further below.
WHAT ARE T-BILLS?
U.S. Treasury Bills are ultra-short Treasury bonds that mature in less than a year. A portfolio of these typically has T-bills that range from 0-12 months in maturity, with securities constantly maturing via a ladder strategy. Many use T-bills as a proxy for cash.
T-bills are stable securities (minimal price fluctuations) that have near-zero credit risk (they are issued by the U.S., after all). They also boast state income tax-free interest.
Some might think it wise to sell their entire portfolio and allocate it to this or something similar, especially in an environment like this. Of course, this is a bad idea, one that will result in real economic loss over time.
By moving 100% of your portfolio to cash, you would be doing the following:
- Indicating with 100% certainty that you think cash will outperform the market (nobody can be 100% of anything, especially market performance)
- Limiting yourself to upside potential (what we think the market may or may not do in the short-term will likely change over time. Remember everyone’s market expectations during 2020 and what actually happened)
- If you hold assets in a taxable brokerage account, selling them will likely have tax implications (don’t pay Uncle Sam any more than you have to)
- You will force yourself to time the market to get back in. As we all know, this is a bit difficult to do, and almost everybody waits too long, missing on the upside.
Understand that you also risk losing out to inflation if your cash yield does not keep up with CPI. Banks are notorious for dragging their feet when it comes to hiking interest rates.
It is a much better strategy to take a calculated bet based on the current economic environment. For more thoughts on the current economic climate and why we have allocated a portion of our portfolio to ultra-short-term Treasuries, see here.
WHILE CASH IS ATTRACTIVE, IT’S STILL NOT THE BETTER LONG-TERM BET
It’s been a while since cash has yielded anything attractive, especially since the Fed adopted its Zero-Interest Rate Policy during the 2010s. So it’s easy to forget that today’s rates are more of a return to normal rather than a foray into an extraordinary foreign territory. 5% yielding T-bills is within the norm.
In fact, T-bills were yielding 14% in 1981 when interest and inflation rates were raging. The U.S. economy was in the dumps (thank you very much, stagflation), and market expectations were pretty lousy.
However, even during this environment, stocks were the better bet. Yes, T-bills and cash had periods where they outperformed stocks, but their limited upside potential has kept their total return far below that of stocks and bonds.
CASH HAS ITS PLACE
Cash has its place, especially for short-term goals (think emergency funds, home down payment, etc.). It can also sometimes have a place in longer-term portfolios, as it does now. Longer-yielding instruments are currently yielding below 5% (the 10-year Treasury bond currently yields 4.8%). It makes sense to move some capital to T-bills.
But this is temporary as the yield curve is currently inverted (a signal that typically points to an upcoming recession). T-bills will not out-yield longer-term Treasury bonds forever.
It is important to avoid getting confused by the two and allocate a short-term solution for your long-term capital. Stocks and bonds are your better bet for the long term.