As investors, we’ve grown accustomed to the steady, higher yields from our cash accounts as compared to prior years. It isn’t uncommon for some high-yield savings accounts and money market funds to be earning 5% or more these days. For cash savers and safety aficionados, these have been halcyon days. But, as the Federal Reserve contemplates lower interest rates, consumers will see the impact on their money market funds and high-yield savings accounts. Federal Reserve rate cuts mean diminished returns on these traditionally safe havens for cash. So, does that mean you should give up your emergency fund? Should you dump your money market fund? Not exactly. In a falling rate environment, it's important to have a plan to adapt.
First, keep in mind that you will likely still want a large portion of your emergency fund as liquid as possible. Even if this means keeping it in your lower-yielding money market fund, or high-yield savings account. These two funds generally earn more than a normal, retail checking or savings account. Just be prepared for a lower return. If you have a six month emergency fund, you might decide to keep only three months liquid and decide on an alternate option for the remaining six month amount. So what are those options?
While yields may be dropping on the most liquid savings options, there are still opportunities to earn a decent return without sacrificing safety. Certificates of deposit (CDs) and bond funds can be good alternatives to consider. But even in this arena, you should look carefully and consider your options.
For example, you most likely will not want to lock-up your money in a 60-month CD for a nominally higher rate, but you may want to shop CDs with intermediate terms such as 9-to-18 months. Consider splitting up your funds and placing them in CDs of differing terms. That way, as each matures, you can then have access to your cash, or find the next best rate at that time. Keep in mind if you have to sell a CD early, you will most likely incur an interest penalty. Three months of interest can be standard.
Bond funds may yield other opportunities. Generally, with bonds and bond funds, in a falling rate environment, the yield on the bond (or fund) may drop, but the price can appreciate. This helps preserve and increase your capital even if the yield is lower than expected. Here too, proceed with an eye to being able to access your money. If you purchase a single bond, you may be locking up your money for too long. Creating a bond ladder can be time consuming and a hassle to manage. You may also incur sales commissions and/or surrender penalties if you need to sell early. With bond funds, this is less the case. You can usually place a trade and receive your cash in a reasonable amount of time. Also, with a fund, you can select how much you want to sell and still have your money working for you. Another plus, is that you can shop for bond funds that offer low expense ratios, greater diversification, maturity, and professional management.
Regardless of where you choose to park your cash, the priority should be on maintaining an emergency fund, not maximizing yield. The money is there for safety first and foremost. The focus in this climate should be on preserving the value of your savings, while having access to it, and not simply chasing the highest returns. By being proactive and adjusting your cash management strategy, you can weather the storm of falling rates.
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