As we look toward 2025, some big names on Wall Street are advising investors to reconsider how they alocate their cash. Cash-equivalent investments like money market funds, certificates of deposit, and Treasury bills are closely tied to the Federal Reserve’s interest rate movements. With the central bank expected to cut rates by a further quarter percentage point next week, bringing the federal funds rate to between 4.25% and 4.5%, these yields might dip. Nevertheless, Americans still seem quite attached to cash. In fact, as of early December, money market funds held a record-breaking $6.77 trillion, according to the Investment Company Institute. This figure is significantly higher than in September, even before the Fed’s first rate cut in four years.
Peter Crane, the founder of Crane Data, noted that money market funds continue to draw assets from lower-yielding bank deposits. Although their yields have reduced, the Crane 100 Money Fund Index, based on major taxable money funds, achieved an annualized seven-day yield of over 5% earlier this year but has since slipped to 4.43%. Crane believes yields will stay above 4% heading into the new year and remain over 3.5% into 2025. “Money funds are still benefiting from their main appeal – market rate returns,” Crane explained, citing attractive short-term interest rates both in nominal and real terms.
The direction the Fed will choose for 2024 remains a bit clouded. While inflation is no longer at its 2022 high, it’s begun to inch up again recently, with the consumer price index hitting a 12-month rate of 2.7% in November, as per the Bureau of Labor Statistics. This is still above the Fed’s 2% target, and wages remain strong, potentially influenced further by President-elect Donald Trump’s policies.
Vanguard, which manages assets totaling over $9 trillion, projects a drop in the fed funds rate to 4% by the end of next year but warns that a bounce back in inflation might slow the Fed’s easing or reverse it altogether. Their outlook suggests that “the era of sound money with positive real interest rates will continue, laying the groundwork for robust cash and fixed income returns over the next decade.”
But why the fascination with cash? High yields alongside economic uncertainty have driven people to park their funds in money markets and similar investments. A July poll by Empower showed that nearly half of Americans, specifically 49%, feel safer with cash compared to other investments. Cash comprises over 27% of their users’ portfolios, Empower noted. Historically, however, keeping a small percentage, say 3% to 5%, of your portfolio in cash is wise for emergencies and liquidity, said Luis Alvarado from Wells Fargo Investment Institute. “Historically, cash as an asset class has significantly lagged over time,” Alvarado pointed out, comparing cash’s returns to a more impressive 35.5% gain from the S&P 500 during another period. Despite 12-month yields approaching 5%, money market funds averaged around a 7.34% return during this period, he added.
UBS chimed in with a note cautioning about cash’s dismal real returns over recent years, with high interest rates not covering inflation’s surge. Since the start of the decade, cash’s purchasing power in U.S. dollars has dropped by 8%, said Mark Haefele from UBS Global Wealth Management. “We see cash continuing to be one of the worst-performing major asset classes,” Haefele stated. He emphasized that as interest rates decline, cash returns are likely to erode, with broader economic factors, such as deglobalization and an aging population, possibly pushing inflation up periodically and diminishing after-inflation returns.
Capital Group’s John Queen compares cash to an “attractive nuisance” in legal terms–appealing but potentially harmful. By the time investors notice falling cash yields, bond markets may have already rallied, missing opportunities to secure attractive yields. “Holding cash makes one a market timer, and few can do that well,” Queen advised. “Cash can be a trap.”
Instead, Queen suggests tailoring investment portfolios to personal risk profiles and timelines, with core bonds playing a key fixed income role. There are chances to explore in structured credit, as well as select areas in commercial mortgage-backed and auto asset-backed securities markets. Wells Fargo advocates for a bond ladder approach, progressively extending durations starting at intermediate levels (3 to 7 years), then moving to longer ones, and finally, shorter maturities, as detailed in their 2025 investment outlook. This strategy can apply when purchasing new fixed-income securities or reallocating among chosen managers.
For income-focused investors, dividend-paying stocks are another avenue. “Major U.S. companies have over $2.4 trillion in cash on hand and could decide to initiate or boost dividend payments,” Wells Fargo observed. UBS similarly advises transitioning from excess cash to investments that offer higher and lasting income streams. Investment-grade corporate bonds have an appealing risk-reward profile, despite being comparatively expensive versus Treasurys. “Combining IG bonds with riskier options like high yield or emerging market bonds can enhance diversification and boost returns,” Haefele suggested. “For single-bond portfolio managers, we recommend focusing mostly on quality bonds but supplementing with select riskier short- and medium-duration credits,” he concluded.
