After years of rock-bottom interest rates, a shift in monetary policy by the Federal Reserve (Fed) to combat stubbornly high inflation has contributed to much higher yields across short-term investment vehicles.
This year, with inflation at its highest since the early 1980s, the Fed has increased its policy rate by 150 basis points (1.50%) with more hikes expected.
Higher policy rates have presented a compelling interest rate environment for those with excess cash looking to earn additional income without necessarily exposing the funds to excess volatility normally found within the equity or longer-dated fixed income markets.
When reviewing investment strategies, it is common for investors to focus solely on stocks and bonds. In the current investment market, those returns can have some volatility.
However, with the recent boost in short-term investment yields, now may be a good time for investors with a low risk tolerance to look at investment opportunities more geared toward lower risk with a focus on preservation of capital and liquidity.
Here are commonly asked questions and answers about short-term cash management investing to help determine if it is a sound investment strategy for you.
What is cash management?
A cash management investment strategy could reduce risk factors that generally create swings in portfolio values based solely on stocks and longer-dated fixed income securities. Cash management generally focuses on short-term investments while taking into consideration an investor’s risk tolerance and most importantly, liquidity needs. These investments include shorter term vehicles like government and corporate bonds, CDs and other money market instruments.
You are essentially lending your cash to various investment entities, like the U.S. government, banks, and corporations, who promise to pay back the amount you invested plus interest over a fixed term.
Why is now a good time to consider investing in short-term fixed income securities?
More restrictive monetary policy this year via higher policy rates has contributed to declines in stocks and fixed income securities. However, higher rates have also contributed to opportunities for short-term investing in fixed income products like short-term CDs, Treasury bills and bonds, and other short-term fixed income securities that generally move in the same direction as the Fed’s federal reserve target rate. As this interest rate goes up, yields on these stable cash investing products generally do too.
For example, a Treasury bond presents virtually no credit risk as it is guaranteed by the U.S. government, can have a very short maturity period if you prefer, and can provide consistent and measurable returns on your investment through interest payouts and the return of your initial investment at the end of the set term.
The 6-month U.S. Treasury bill was yielding 18 basis points (0.18%) on December 31, 2021. Six months later, after multiple rate hikes by the Fed, it was yielding roughly 2.48% – a difference of over 200 basis points (2.00%).
Why Is This Happening Now?
This year’s volatile equity markets have investors trying to digest the actions of the Fed as it continues to raise interest rates to slow the economy in an effort to corral inflation. While some investors may choose to sit on the sideline, the Fed’s policy has created an intriguing investment environment for those who are more risk averse but like the idea of earning money on their cash without locking up it up for a long period of time.
What should my investment mix look like?
Diversifying investments is important in any economy, and your portfolio should reflect your life stage, cash management needs and risk appetite.
While the stock market can be volatile, it also rises in value over time, bringing your mix of stocks and funds along with it. These investments typically require patience to reap the full return.
If you require more consistent access to invested cash, fixed income products can help you balance your overall portfolio during economic uncertainty as well as long term.
For investors that have excess cash but aren’t necessarily interested in exposing principal to potential wide swings in the market, a cash management strategy may be appropriate.
Your mix depends on your needs over time, so there is no set approach that works for everyone. Talk to an advisor to determine the best approach for you.
Helping you boost your financial intelligence.
Read our financial resources from your friends at WSFS.