As expectations continue to rise that the Federal Reserve will cut the Federal Funds rate (the interest rate banks charge each other for overnight borrowing of reserves), money market rates will in turn also be impacted. Investors should consider how these changes may impact their portfolios and how best to prepare for a lower-rate environment.
Most investors maintain a certain level of cash invested in a money market mutual fund within their portfolio. Over the past several years, we have been able to enjoy returns in excess of 4% on that cash. In addition to the excess cash investors have, due to the higher money market returns, investors have been tempted to also keep their fixed income investment allocation in a money market fund. While this strategy may have worked over the past two years, with the Federal Reserve likely on the cusp of resuming interest rate cuts, it may be a good time to rethink this strategy.
We’ve seen historically that as the Fed begins to cut rates, returns on money market funds steadily decline as their yields closely track the Federal Funds rate. The following chart displays the 3-month Treasury bill money market yield versus the Federal Fund rates.
Money Market versus Federal Funds Rates
What should I be doing with my cash now?
For those holding cash for short-term liquidity needs, a money market fund continues to be a good option. However, for those holding their portfolio’s fixed income allocation in a money market, we believe now is the time to begin moving to longer maturity fixed income securities to lock in the higher yields. At Ancora, our fixed income team typically prefers a laddered bond portfolio approach with staggered maturity dates, as we believe that can be beneficial for investors seeking to manage risk-generating income. The laddered bond portfolio approach allows investors to capture various points of the yield curve, essentially locking in yields for an extended period of time. In addition, in a laddered portfolio, when a bond matures, investors can choose to reinvest the principal at the current market rates, redeploy the principal in a different asset class such as equities, or simply keep the funds in cash for liquidity needs. Please reach out to your Ancora advisor to further discuss how to better position your fixed income portfolio for different interest rate environments.