Many Investors (Surprisingly) Stay Put When Market Rates Fall

I’m paying attention to the recent Fed cuts having stored more funds than usual in Vanguard Money Market Funds (MMFs) (enjoying those 5.25%-plus low-risk yields over the past couple of years). But these real and potential Fed cuts will likely come to pass in the presence of an over-valued stock market – certainly one that’s pricy enough to cause this old codger to exercise some patience before shifting funds to a stock market showing signs of losing upward momentum.

Why Be Patient?

Patience might be in order for no other reason than to ascertain at what reduced rate level Money Market Account (MMA) and MMF owners will start to bail with these current low risk dollars. Despite the Federal Reserve's recent 1/2% interest rate cut, investors have poured an additional $100-plus billion into MMAs and MMFs, bringing the recent total to almost $6.8 trillion…a record, according to Crane Data.

That’s quite a lot of idle cash, some of which will likely seek new investment opportunities should the Fed follow suit with two more 1/4% rate cuts by the end of 2024. And who knows what 2025 might bring in additional cuts.

Shifty Assets

In short, at what rate level will money market dollars start looking for new homes in more risky assets (stock) and/or less liquid assets like bonds and CDs? When rates fall, prices for existing bonds tend to rise simply because they carry higher rates of interest than newly issued bonds. And when rates fall, those friendly financial advisors will predictably try to steer clients out of money markets and into bonds and other more risky instruments.

However, I’m of the opinion that in recent years many new MMA and MMF investors have simply shifted low-yielding bank savings account funds into money markets and may decide to remain there as new homes for emergency (rainy day) funds instead of chasing riskier investments. (Food for thought.)

Safe (Liquid) Havens

Although they’ve quickly tumbled below 5%, money market rates may remain attractive to many investors even if they drift below 4% toward 3%, simply because of this newly discovered attractiveness as a safe, highly liquid emergency fund, particularly if the stock market remains robust. Still, with trillions of dollars resting in money markets, there appears to be a substantial population of investors holding the opinion that some of that trove will find its way into the stock market giving that market still another leg up.

But if rates are slow to fall, if stock valuations remain relatively strong, if Treasury and other bond yields drift down, a major shift from cash to stock and other, riskier choices may not be of major magnitude. Because of their inherent flexibility and risk level, investors with short-term cash requirements may continue to enjoy the attractiveness of MMAs and MMFs even as their yields track Fed rate reductions.

Emergency Measures

I have long touted the benefits of storing cash in MMFs rather than in your friendly local banker’s low-rate savings and money market accounts or more illiquid CDs. True, as long as you have an account with an FDIC member bank, your deposit—including principal and interest—is automatically covered up to the FDIC limit ($250,000). If an investor’s money market is a form of mutual fund (MMF) in a brokerage account with a company like Vanguard, it is not covered by the FDIC. However, the risk is minimal since most MMFs in brokerage accounts are invested in near cash and liquid near-term instruments like short-term Treasuries.

With that said, Vanguard has a Cash Plus Account, a cash management account that features a bank sweep insured by the FDIC. It offers a slightly less, but competitive yield on short-term savings as a low-risk place to keep cash for those emergencies. Vanguard members have the option to purchase any of the company’s five Vanguard money market funds, which are available in the investor’s Cash Plus Account. This account is an alternative to a traditional savings account. It offers a bank sweep program whereby eligible balances are swept to program banks and are eligible for FDIC insurance of up to $1.25 million for individual accounts and $2.5 million for joint accounts.

And, by the way, a nonprofit membership corporation called the Securities Investor Protection Corporation protects customers of SIPC-member broker-dealers like Vanguard if those firms were to fail financially. It protects brokerage accounts of each customer up to $500,000, including up to $250,000 for cash. Note: SIPC insurance doesn't cover losses related to decline in market value. No surprise there.

Banker's Dozen

In as much as they offer very low-risk, higher yielding, and very accessible cash sources, more and more folks are recognizing such accounts as all-important stores for emergency funds that are so important in helping an investor avoid unanticipated raids on retirement portfolios or meeting unexpected financial needs. Bank savings accounts are not necessarily generous rate sources for holding rainy day funds. In recent months and years, it wasn’t uncommon for brokerage MMFs to yield 5.25%-plus while those steely-eyed bankers paid 1/2% or less on savings accounts.

But be advised, MMFs with large fund companies like Vanguard may come with minimum balance requirements (usually quite small), may limit the number of withdrawals per month (six or so), and may have a minimum check amount limit ($250 or so). But the difference in yields versus bank options can often be too significant to ignore (divide 5.25% by 1/2%). I’ve used MMFs for years as a readily available cash source, and I can’t recall an instance where they haven’t met my emergency cash needs.

For purposes of transparency, bank and credit union checking accounts, without question, have one important advantage over MMAs and MMFs – unlimited transactions, ATM, wire transfer, and check writing capabilities, etc. And the associated FDIC and National Credit Union Association (NCUA) insurance that comes with those checking accounts can be very comforting.

But it comes with a high price.