The Trouble With ‘Locking In’ Today’s High Cash Yields

With the Fed widely expected to cut rates later this year, many who enjoy higher yields on money market funds and high-yield savings accounts are apparently on the hunt for ways to lock in today’s relatively high rates. We say that because a flurry of articles recently highlight “options,” like one popular piece in Wednesday’s edition of The Wall Street Journal. We get the appeal, but seeing the world this way is a potentially big personal finance mistake. Let us dive in.

That mistake: viewing the investment world through the lens of yield only. As in, I have this pile of money, it is earning X%, and if the Fed cuts rates, I need to make sure this pile of money keeps earning X%, come what may. The problem: Yield is compensation for risk. Therefore, a security that boasts a high yield in the aftermath of Fed rate cuts and falling money market yields is probably taking more risk than cash or cash equivalents.

Still don’t see the problem? Consider why people tend to hold cash in the first place. If their goals and needs are driving the decision, then money in cash is most likely an emergency fund or money earmarked for a very near-term purpose, such as a down payment on a home. In both cases, it is money people need instant access to—and they need to know the amount they have today is the amount they will have tomorrow.

Flipping from money market funds and traditional savings accounts to higher-yielding vehicles ignores this and runs a high likelihood of exposing savings cushions to unwanted and misunderstood risks. To see this, consider some of the vehicles the Journal’s piece mentions. One is a certain type of deferred annuity that offers CD-like yields for longer maturities. As the article notes clearly: “These products are illiquid and may have stiff early-surrender charges that eat up anywhere from 5% to 8% of the value.”^[i] This cuts completely against why someone would hold cash! If you need a new roof or find that perfect home, the last thing you want is to pay through the nose to access your money to pay for it. And if you don’t need the liquidity, the decision to lock in today’s cash-equivalent yields could amount to missing a lot of return and compound growth in stocks, bonds or a blended portfolio. That opportunity cost can be huge in the long run. 

The other suggested alternatives are funky bond ETFs, preferred stock and a certain type of corporate bond. All are debatable on the merits, in our view, but the larger issue here is that all are subject to short-term volatility. So you are losing the stability that comes with cash—again, counter to the purpose of holding it. The bond-like instruments here are more in the realm of Treasury and traditional corporate bond securities and funds, which makes them part of the fixed income conversation, not the cash conversation—which means they relate to entirely different sets of goals and needs. Some of the funds use leverage, which magnifies volatility, compounding the inherent mismatch and running counter even to fixed income’s primary purpose of reducing expected short-term volatility versus an all-stock portfolio.

Essentially, articles like this encourage investors to view cash incorrectly: as a return engine. It is more akin to a parking spot. The whole purpose of interest paid on cash and cash equivalents is to offset, at least partly, inflation’s long-term erosion of purchasing power. It is to mitigate a risk, not add to returns. If you flip to a return mindset, losing sight of the purpose for the money in question, then you risk ending up in illiquid, volatile products that aren’t a fit for your needs. And again, parallel to this, if the goal was always returns, then cash was a terrible way to do it even at high yields because of the high opportunity costs involved (not to mention inflation risk and taxation).

This is a big reason why we always counsel against chasing yield. It can look like a big easy button, but easy buttons don’t exist. There is no free lunch. High yields that exceed money market funds and Treasurys will always be compensation for volatility, illiquidity, default risk or some combination of the three. Don’t let the allure of an “easy” X% lead you astray. Always focus on your goals, needs and time horizon first and foremost. Let those, not an advertised yield, be your north star.