Despite interest rates at historic lows, there are options to find a better return for your excess cash. U.S. Treasuries, while safe and liquid, offer lower yields. Money market funds, CDs, savings accounts and bonds may offer higher yields, however each one offers a different level of risk and liquidity. Be sure you understand the pros and cons of each.
As the U.S. Federal Reserve Bank wages economic war against COVID-19, investors sitting on excess cash have subsequently watched their cash yields dwindle to near zero. Given this reality, where can investors park excess cash to earn a respectable yield?
Any discussion of hunting for yield needs to begin with the obligatory disclosure that there are no free lunches in financial markets. And so it is with interest-bearing investments; rock-solid government guarantees come at a hefty price in the form of low yields.
Short-term U.S. Treasuries, typically the safest investments, are also among the most deeply liquid securities in the market. Today, the U.S. Treasury is a $20 trillion market. However, safety and liquidity come at the expense of historically low yields. Currently, two-year treasuries pay a paltry 0.20% annually with five-year treasuries offering only slightly more at 0.34% annually.
Pros: safety and liquidity
Cons: lower yield
Money market funds invest in short-term term, high-quality, high-liquidity cash, cash equivalents, and highly rated debt. Most money market funds invest in securities maturities of less than 13 months. Despite this safety, there are no U.S. government guarantees for money market funds, nor are they FDIC-insured. While the funds themselves may invest in short-term treasuries, they also invest in near-term, high-quality debt issued by U.S. government agencies, banks, and corporations. And while the risks are low, money market funds are certainly not risk-free. Because of this, they typically offer investors a slightly higher yield than that paid by treasuries. One of the higher yielding money market funds, Schwab’s Value Advantage Money Fund (SWVXX), currently offers investors a 0.60% annual yield.
Pros: potential for higher yields, liquidity
Cons: not FIDC-insured, not risk-free
|Asset Class||Yield||Ave. Maturity|
|2-Year Treasuries||0.20%||2 Years|
|5-Year Treasuries||0.34%||5 Years|
|10-Year Treasuries||0.58%||10 Years|
|Treasury Inflation-Protected Securities (TIPS)||-0.38%||10 Years|
|Money Market Funds|
|Schwab Value Advantage Money Fund (SWVXX)||0.60%||24 days|
|Federated Government Obligations Fund (GOFXX)||0.28%||39 days|
|Fidelity Money Market Fund (SPRXX)||0.37%||37 days|
|5-Year CD Ladder||1.00%||2.5 Years|
|Bloomberg Barclays US Aggregate Bond Index||1.59%||8 Years|
|Mercer Advisors Short-Term Fixed Income Portfolio||2.68%||2.6 Years|
Many banks offer high-yield savings accounts; some, even today, offer savings accounts with yields well over 1%. However, those rates typically come with conditions such as requiring an investor to open a bank account with the financial institution or doing a certain amount of checking business with the bank. After all, banks ultimately want to earn your checking account business which is, surprisingly, a highly profitable business. But switching financial institutions can be quite a painful and time-consuming chore.
Pros: potential for higher yields, FDIC-insured
Cons: higher yields but need to have a banking relationship
Investors who need rock-solid guarantees but don’t want to start a relationship with a new financial institution may want to invest in FDIC-insured bank CDs, a sleepy asset class that’s often overlooked. Investors can invest in CDs offered through most major custodians, such as Fidelity and Schwab. But despite their FDIC protection, bank CDs can also offer higher yields than treasuries. For example, the sample five-year CD ladder in Exhibit A pays investors an annual 1% yield and has an effective maturity of 2.5 years.
Exhibit A: Sample Five-Year CD Ladder (as of April 22, 2020)
|GOLDMAN SACHS USA (NY)||0.60%||2021|
|JP MORGAN CHASE BANK||1.00%||2022|
|FLAGSTAR BANK, FSB||1.05%||2023|
|CENTERSTATE BANK OF FLORIDA NA (FL)||1.05%||2024|
|HSBC BANK USA (VA)||1.30%||2025|
There are some downsides to investing in bank CDs. First, FDIC protection is limited to $250,000 per depositor, per FDIC-insured bank; investors should be careful not to exceed the FDIC limit by purchasing more than $250,000 in CDs from a single bank. Second, investors can’t easily liquidate their CDs in the event of an emergency. Subsequently, investors should expect to hold their bank CDs until maturity.
Pros: FDIC-insured, potential for higher yields
Cons: limits to FDIC-insurance, not easily liquid
For those investors willing to forgo guarantees and money markets, there is always the broader bond market. Naturally, some bonds are obviously riskier than others, but investors don’t need to invest in high-yield, low-quality bonds to earn a little more yield. For example, Mercer Advisors’ Short-term Fixed Income Portfolio, which includes bond mutual funds from Fidelity, Vanguard, and Dimensional, currently offers a yield of 2.68%. According to Morningstar, the portfolio’s underlying bonds have an average credit rating of A with an average maturity of 2.6 years. To learn more about this portfolio, please contact your advisor.
Pros: potential for higher yields
Cons: not FDIC-insured