The Federal Reserve took short-term interest rates down to nearly zero during the financial crisis 15 years ago.
Then – to the surprise of just about everyone – it left them there for over 13 years.
With Treasury bills and money market accounts paying next to nothing – and in some cases literally nothing – the conventional wisdom was that “cash is trash.”
What a different world we’re living in today.
Thanks to those zero interest rates… plus blowout spending by President Biden and congressional Democrats… plus COVID-19 shutdowns that brought the global supply chain to a screeching halt, we’ve experienced a sharp rise in consumer prices.
To combat the highest inflation in more than 40 years, the Fed has raised interest rates 5 full percentage points over the last 14 months.
That has knocked down stock and bond prices from their highs early last year.
Meanwhile, the Vanguard Federal Money Market Fund (VMFXX) now yields over 5%.
“Why should I take the risk of investing in stocks or bonds,” a reader asked last week, “when I can get 5% in a risk-free government money market fund?”
It’s a good question.
And I’ve got a good answer: Because that yield may not last long.
And because over the last 80 years the Dow and S&P 500 have generated an average annual return that is twice that.
As Patrick Henry famously said, “I know no way of judging the future but by the past.”
Don’t get me wrong. I hold my own cash reserves in the Vanguard Federal Money Market Fund. It’s super safe, super low-cost and super liquid.
According to Bankrate, it’s the highest-yielding money market fund in the nation.
Yet, for serious investors, cash should never be more than a temporary holding place.
Money market yields are high today because inflation is high. After deducting inflation, Vanguard’s money market fund is a net money loser.
(Although it’s less of a money loser than the 99% of money market funds that yield less.)
According to Vanguard, the fund has returned 1.85% year to date.
(Remember it wasn’t yielding that much at the start of the year. And it may not yield that much at the end of the year either.)
The fund has returned considerably less than the nearly 10% return of the S&P 500 year to date.
And it’s lagged the Nasdaq, which is not only up 25% but officially back in a bull market, by even more.
Yes, there is a possibility that we could have a recession in the months ahead and the market would turn south again.
If that happens, however, the Federal Reserve is likely to step in and cut rates again to stimulate the economy.
That would be good for stocks. But it would be bad for money market yields.
Why? Because these funds hold only very-short-maturity debt, generally T-bills and high-grade commercial paper.
When the rates on those go down, so will money market yields.
So, enjoy those high yields while you can. But don’t overdo it.
Unlike bonds – or even certificates of deposit – a money market yield is not locked in for any length of time.
After inflation, you’re earning essentially nothing. (Not the best way to increase your net worth or grow your portfolio.)
History demonstrates that no asset class outperforms a diversified portfolio of stocks over time.
In sum, for over a decade money market yields were so low that T-bills and money market accounts were hardly worth considering – except as a parking place for money that was soon to be spent or invested.
But plowing long-term capital into a money market fund today to collect a 5% yield that may be gone tomorrow is not sensible risk management.
It used to be that cash was trash. That’s no longer true.