Investors moved roughly $1.3 trillion into money market funds during 2023, bringing the total to nearly $6 trillion—an all-time high. Many were looking for safety and certainty after the equity and bond sell-off of 2022. Some were reassessing their long-term asset allocations in the new, higher-yielding environment. All were “paid to be patient” with a high cash rate that has been ahead of inflation for nearly a year.

As short-term rates peak, however, we believe the opportunity costs of holding excess cash are growing. Keep in mind that before the rate hikes of 2022 – 2023, when the cumulative return of cash was 7.5%, that return was far lower—just 2.5% on a cumulative basis from 2009 – 2017. Although few anticipate a return to near-zero rate policy, we believe declines are likely from here. In this context, investors may intend to return to the asset allocation they had before 2022, or ease back into a more fixed income-oriented, higher-yielding long-term asset allocation—but either way, we believe it is time to make that money move.

In this article, we consider the issue of excess cash, focusing on three key questions:

• Is holding cash more attractive than locking in bond yields?
• Should you wait before buying more equities?
• Overall, where can you deploy excess cash?

Is holding cash more attractive than locking in bond yields?

Today’s cash rate is considerably higher than the pretax yields on U.S. Treasuries and municipal bonds, and slightly lower than for short-maturity investment-grade corporates. But many think cash rates are on their way down, from close to 5.5% today to below 4.5% by the end of next year. Investing in longer-maturity bonds today may provide the opportunity to enjoy elevated yields until the bonds mature.

Cash is Unlikely to Offer Today’s Rates Forever

Forward Three-Month Cash Rates vs. Current Bond Yields

 

Source: Refinitiv, Neuberger Berman. Data as of April 16, 2024. Short-duration IG corporate bond index is the ICE BofA 1-3 Year U.S. Corporate Index. U.S. municipal bond index is the ICE BofA U.S. Municipal Securities Index. Tax equivalent yield is for an investor in the highest federal tax bracket. Current yields of the U.S. two-year Treasury are the coupon rate divided by the current bid price. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. Past performance is not indicative of future results.

Even in two-year U.S. Treasuries, we believe there is now value in locking in current coupons—and we see still more value in locking in yields in the intermediate (four- to six-year) part of the curve.

The relative value case looks even stronger in municipal bonds, in our view, once tax advantages are taken into account. And cash now slightly trails the yield on short-maturity investment-grade corporate bonds. Investors are right to ask whether a growth slowdown would put corporate bond repayments at risk—but investment-grade defaults have been extremely rare and almost always have been more than offset by their yield advantage over Treasuries, even at levels akin to where they are today. ¹

Unless cash rates decline far more slowly than the market anticipates, or short-maturity investment grade defaults rise substantially, we think bonds now look more attractive than cash. At inflection points like this, we believe active fixed income management can add value through selective yield curve and credit exposures.

Should you wait before making new equity investments?

When cash is paying 5.5% and stock valuations are quite high, it can be tempting to wait for a market correction. However, as the well-worn saying puts it, “Investing is about time in the market, not timing the market.”

Over the long term, equity markets have tended to climb steadily, punctuated by sometimes deep and sharp declines. For example, the losses in the very worst months in the S&P 500 Index’s history have been markedly larger than the gains in the very best months, but overall, our research finds that there have been around 50% more positive months than negative months. The comparative rarity and sharpness of sell-offs is what makes them difficult to predict, and that is one reason why we think equity investors have generally been paid a premium to stay invested.

Thinking long term, therefore, it is difficult, in our view, to justify holding cash rather than stocks unless you believe that the economy is likely to stagnate indefinitely, or that valuations are so high that equities don’t add any value over other assets. Moreover, it’s worth considering that since 1979, equities have generally performed well relative to bonds and cash both during rate increases and once the weight of an interest-rate hiking campaign has been lifted, with the exception of the dot-com bubble era (see display).

Stocks Have Performed Well After Rate Hikes

Return in 12 Months After Final Fed Rate Increase

 

Source: Bloomberg, Neuberger Berman. Data as of December 31, 2023. Historical trends do not imply, forecast or guarantee future results. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. Past performance is not indicative of future results.

Where can you deploy excess cash?

Although you may be a raging bull at this point, it’s also possible that you remain relatively cautious in the face of high equity valuations and uncertain ramifications of still-tight monetary policy. Assuming that you are persuaded that holding cash is no longer optimal, where can you put that money to help achieve your investment objectives? For purposes of discussion, we’ve framed those objectives as (1) income generation (with modest price volatility and diversification), (2) equity exposure with lower volatility and (3) further diversification, and provide possible solutions within each category.

Time to Act

Yields on cash and money market funds have become far more compelling over the past two years. Today, however, interest rates appear to have peaked. Given the potential declines from here, we think that bonds may now look more attractive than cash, while equities remain appealing despite stretched valuations, given their tendency to outperform after tightening cycles and over the long haul. That said, caution is often an asset, and investors may consider looking at areas of the market with risk-mitigation characteristics to help weather what remains an uncertain economic and market climate.