The Importance of Actively Managing Cash

Which is the best cash alternative, short-term bond funds, Treasury Bills, certificates of deposit (CDs), money market funds or one of the many other options available?  Over the last 18 months, the answer has been all of the above. At various times during the past 18 months, each of these cash alternatives has been the most attractive option at a given point in time which underscores the importance of actively managing cash positions.

Since early 2022, interest rates on cash and cash alternatives have been moving upwards from a baseline of near 0%. This is a direct result of the actions of the Federal Reserve to increase rates. While the headlines often emphasize the downside of increased rates, investors with cash reserves can now realize a meaningful return on their cash. Many cash alternatives are paying in the high 4% range with some paying over 5%.

Except for a brief period of time in the years 2006 and 2007, yields on cash have not been as attractive as they are today in over 20 years. Given such a long period of low to almost 0% yields on cash, it’s understandable that consumers have been slow to take advantage of these higher rates. As a client of F2 Wealth, you have benefitted from the increase in rates through our active management of your cash holdings. As a client, you can be confident that we have been regularly evaluating cash holdings and the many cash alternatives available in the market to get attractive yields on your money for you. We are not favoring cash over stocks or even bonds for long-term investors, but for those clients with short-term cash reserves there are benefits to having cash positioned to benefit from the current rates.

With the best yields rotating among multiple types of assets, we continually monitor the market and adjust cash holdings accordingly. Some examples of cash alternatives are listed below.

 

Cash Alternatives

Treasury Bills

These are securities issued by the U.S. Treasury with maturities of 1 year or less. They are generally considered to be a nearly risk-free asset. However, there are unique risks in the Treasury market at the current time due to the ongoing negotiations over the debt ceiling. These risks are particularly worth noting for Treasurys with maturity dates over the Summer months because this appears to be the most likely time that a government default could occur. While most professionals deem a default a highly unlikely event, it is nonetheless an event that can’t be ignored.

Money Market Funds

These are mutual funds that invest in a variety of cash-like assets with the goal of maintaining a constant share price of $1 while paying an attractive rate of interest. Money market funds come in a variety of types including funds that invest in government and municipal securities. Because certain money market funds may be tax-advantaged, it’s important to always compare after-tax yields. Some funds may hold Treasurys which means the same risks involved with direct ownership of Treasurys apply to money market fund holdings as well. 

Certificates of Deposit (CDs)

CDs are familiar to most but what might not be as familiar is the many varieties of CDs available. CDs are available at banks and in brokerage accounts and include standard term CDs along with callable and step-up CDs. Each type of CD carries with it its own set of risks and benefits which must be thoroughly examined to choose the best type for a given situation.

Ultra-Short Bond ETFs

These are securities that invest in a portfolio of fixed income securities of maturities typically of one year or less. The share price will fluctuate on a daily basis and investors are subject to a loss of principal. The trade-off for the risk in loss of principal is the possibility of higher returns relative to other options.

Other Alternatives

There are many other assets available that are considered as alternatives to cash that may offer a higher yield on invested funds. We are continually on the watch for compelling opportunities to increase the return on your money. For a variety of reasons we do not find most of these other assets attractive at the present time. These reasons include high costs, unattractive risk profiles, interest rate risk, and term risk. However, we do remain nimble in our approach, and always enjoy finding an uncommon solution to a client goal.

 

Portfolio Considerations

Principal Risk

When it comes to cash alternatives, nothing is guaranteed. However, there are choices that are safer than others. For example, CDs are backed by FDIC insurance (subject to certain conditions) which is generally considered a solid guarantee that investors will get their money back even if the bank fails. Money market and ultra-short bond funds have no such guarantees, although both have been resilient in times of financial market stress.

Liquidity

We consider your need for liquidity when evaluating your cash holdings. Certain holdings can be sold and available in a day or two, while others may need to be held to maturity which could be months or years.  It is worth noting that the cash alternatives we typically use can be sold on the secondary market which does provide a way for an asset to be sold before its maturity date.

Term and Interest Rate Risk

One key question to answer at the moment when selecting cash alternatives is how long the term of the investment should be.  Until now, it’s been best to keep the term very short using terms of 6 months or less sprinkled with some allocation up to 1 year. As the Federal Reserve is indicating that we are nearing the end of rate increases, it may be time to consider extending terms in an effort to lock in higher interest rates while they are available.

Taxes

As with any investment, “it’s not what you earn but what you keep.” This saying is also applicable to managing cash. Some cash and cash alternatives are taxed as ordinary income, while others avoid certain taxes. For example, savings accounts and CDs are subject to both federal and state income tax. Money market funds are more complicated in that some are taxable at both federal and state levels, some avoid state taxation, and some avoid both. When comparing cash alternatives, we always compare after-tax yields based on your individual tax situation.

 

Our Process

The cash portfolios managed on your behalf are constructed based on the specifics of your individual situation. We do not use a one-size fits all approach. We monitor your holdings on an ongoing basis to determine when cash becomes available so that it can be reinvested in the most attractive options available for you. We consider after-tax yield, issuer risk, term risk, interest rate risk, call provisions, economic conditions, etc. and your personal risk preferences when constructing cash alternative portfolios. The most important consideration is always what’s best for your personal situation.