While money markets may seem like a safe and secure place to park your cash, there are a number of reasons why you may want to consider other options. In this blog post, I'll discuss three reasons why you may want to move beyond money markets and invest in other assets.
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Lower “real” return
When you factor in inflation and taxes, the income generated by money markets is less enticing. Consider this hypothetical example: $100,000 invested in a money market yielding 3.5% would earn $3,500 in interest a year. When factoring in 6.4% inflation and a 37% income tax rate, the real return on the investment is actually a loss of $4,658.1SourceMoneyGuru-https://www.mgkx.com/5034.html
Lower return over time
Short-term cash-like investments have historically generated significantly lower return than longer-term government bonds, corporate bonds, and stocks, as the example below shows.SourceMoneyGuru-https://www.mgkx.com/5034.html
| Asset Class | Average Annual Return |
|---|---|
| Money markets | 3.5% |
| Long-term government bonds | 5.5% |
| Corporate bonds | 7% |
| Stocks | 10% |
Yes, cash-like investments may outperform Treasuries over short time periods, but using the same 30-year time period as the example above, Treasuries outperformed cash during 98% of the rolling monthly 10-year periods during the past 30 years.SourceMoneyGuru-https://www.mgkx.com/5034.html
Locking in long-term rates may be better
Reinvestment risk is among the biggest challenges of investing in short-term securities, such as money markets, because that money generally has to be reinvested every few months. At some point, interest rates will fall from today's elevated levels, and the money market will have to reinvest in lower-yielding securities. Investors who like today's yields may be better off locking them in for the longer term with bonds.SourceMoneyGuru-https://www.mgkx.com/5034.html
How might investors move out of cash?
Let's look at three instances when cash balances were high — following the 1991 and 2002 recessions, the 2008 Global Financial Crisis, and the 2009 European debt crisis — and calculate what $12,000 invested yearly in the stock market for 10 years would have been worth. Since there are many ways to put cash back to work, I considered four investing scenarios:SourceMoneyGuru-https://www.mgkx.com/5034.html
- Perfect timing assumes that an investor maximized their return in the S&P 500® Index each year.
- Worst timing assumes that an investor minimized their return in the S&P 500® Index each year.
- First of the year imagines an investor moving the entire $12,000 into stocks as a lump sum at the start of each year.
- Dollar cost averaging assumes an investor made a $1,000 per month investment in the index yearly.
I compared each of these strategies with the returns an investor would have if they simply continued to hold cash (calculated using the Bloomberg 1- 3 Month US Treasury Index).SourceMoneyGuru-https://www.mgkx.com/5034.html
In each instance, investors would have been better off investing their money in stocks versus holding cash — regardless of how they did it. Investing a lump sum at the first of the year and dollar cost averaging were both sound strategies. While all investors would like perfect timing, even having the worst timing each year still outperformed cash.SourceMoneyGuru-https://www.mgkx.com/5034.html
Conclusion
While money markets may seem like a safe and secure place to park your cash, there are a number of reasons why you may want to consider other options. If you're looking for a higher return on your investment, you may want to consider investing in longer-term assets, such as bonds or stocks. If you're concerned about reinvestment risk, you may want to lock in long-term rates by investing in bonds. And if you're not sure when to invest, dollar cost averaging may be a good strategy for you.SourceMoneyGuru-https://www.mgkx.com/5034.html
No matter what your investment goals are, it's important to speak with a financial advisor to get personalized advice. They can help you assess your risk tolerance and recommend the best investment options for you.SourceMoneyGuru-https://www.mgkx.com/5034.html SourceMoneyGuru-https://www.mgkx.com/5034.html
