By Dr. Jim Dahle, WCI Founder
I fully understand that high(er) interest rates are not good for everyone. Mortgage rates are now around 7%-8%. 2023-2024 federal medical student loans are at 7.05% and 8.05%. The cost of borrowing has gone up for every business and every individual. Higher rates aren't necessarily even good for my overall finances (the WCI student loan refinancing product line has been predictably decimated). However, unlike the last 20 years, it sure is nice to finally feel like I'm not being punished for being a relatively debt-averse net saver.
Positive Real Returns on Cash
As I write this post on September 6, 2023, my chosen cash holding (The Vanguard Federal Money Market Fund) has a seven-day SEC yield of 5.27%. That's the highest it has ever been since I became an investor with my first paychecks way back in 2003 (it was close in 2007 before rates were cut in response to the global financial crisis). Meanwhile, inflation as measured by CPI-U is at 3.18%. Thus, cash has a real (after-inflation) return of over 2%. That's remarkable to this investor and pretty exciting. Yes, it's still not an awesome return for ME after-tax ([1 – 37% -4.85% – 3.8%] × 5.27% = 2.86% nominal), but the more volatile Vanguard Municipal Money Market Fund is paying 3.90% for those of us with high marginal tax rates and a willingness to monitor rates frequently. That still provides a positive real, after-tax return.
The yield curve is also still inverted
with five-year, 10-year, and even 30-year Treasuries yielding less than T-bills.
There are several benefits of this environment, and you should take advantage of them.
#1 No Rush to Invest
Perhaps the greatest benefit of earning 2% real without taking any risk is that I no longer feel a big rush to get my money “working for me” as quickly as possible. Yes, I need to get it out of my checking account(s) and into that money market fund. But once it's there, I have plenty of time to do “investing chores” and to wait for the right opportunity (as far as illiquid investments go).
#2 Easy Short-Term Savings Decision
Most of us have at least some short-term savings decisions. For me right now, it's my new truck and my quarterly estimated tax payment. When rates were low (and especially when real rates were negative), we all had a difficult decision to make with our short-term savings. Do we take on a little risk in the hope of a little more return? No need to bother anymore. Just plunk it into your cash account and quit worrying about it. In the short run, cash has a higher expected return than any bonds, and you weren't going to take on equity risk anyway.
#3 No Cost to an Emergency Fund
When talking about your emergency money, the (rapid) return of your principal matters more than the return on your principal. However, there is usually a cost to having that “insurance”—the cost being a relatively poor return. Well, no more. Now, you can earn 5%+ on your emergency fund. So, WHY NOT have one? “Free” insurance.
More information here:
What Happens When You Actually Have to Use Your Emergency Fund?
#4 Higher Expected Returns on All Assets
Yes, when interest rates go up, the value of your stocks, real estate, and bonds (especially bonds) typically falls. However, savvy investors also realize that FUTURE returns on those same assets just went up. Maybe your bond fund with a duration of five years fell 10% in value as rates went up 2%. But it also yields 2% more, and since the best guess of future returns is the current yield, your expected return just went up 2%. In fact, after five years, you'll actually be ahead with higher rates.
While not as obvious, the same thing applies to stocks and real estate. Yes, the cap rate went up on that investment property, and its value fell. But (all else being equal) higher cap rates mean a higher rate of return on the current value. Plus, if rates fall in the future, you'll get a “kicker” on that return as the property goes up in value. Stocks also must (theoretically) provide higher returns. Why would someone accept 2% real returns on stocks when they can get that on cash?
#5 Easy Decision When Carrying Low-Interest Rate Debt
When interest rates on cash are low and you're carrying 2%-3% debt, you wonder if maybe you should just pay it off. When you can get 5%+ on cash, that decision becomes really easy. Sure, you may still decide to get rid of the debt for cash flow and/or psychological reasons, but there are no tough math/risk decisions to make.
More information here:
Should You Pay Off Debt or Invest?
High(er) interest rates have their pluses and minuses. You might as well take advantage of the pluses.
What do you think? What benefits are you enjoying from the increased rates on cash? Where is your cash right now? Comment below!
Thanks for the post!
Curious, why aren’t you using Vanguard’s Municipal Money Market Fund (VMSXX)?
It has a current yield of 3.75% which has a tax-equivalent yield (in the 39% tax bracket) of 6.2% and depending on the state you’re in, you could see 6.75%+.
I personally have found this fund superior to Vanguard’s federal money market funds. Thanks for your thoughts!
Mostly because the relative yields change so frequently and I wasn’t checking enough that I found myself in the municipal fund when I should have been in the federal fund. More details here:
https://www.whitecoatinvestor.com/municipal-money-market-yield-volatility/
What a great post. As a 56 year old retiree as of end of year, I have an abundance of choices to make for my bond allocation/cash that was fortunately hiding in a stable value fund in 2022. What a good problem. I just constructed a 10 year CD ladder with about half the money, am keeping 2 years of living expenses in SGOV a very short term bond fund yielding about 5.2% that’s like a money market, and am holding the rest in a mm and treasuries that come due in 2024 that I’ll probably add to my rolling CD ladder, perhaps in the form of ishares ibonds treasuries and corporates etfs which are more liquid than treasuries or cds and pay out monthly. We are fortunate to have these choices and I want to take advantage now because perfect is the enemy of good. And these rates are really good!
Sorry if this has been addressed elsewhere, but are there advantages to money market funds over high yield savings accounts? I’m getting 5.00% at Wealthfront at the moment.
Thanks!
Sometimes (like now) it has a higher yield. No FDIC protection though. Less needed of course. Either is a reasonable choice.
I just stopped making extra principal payments. Should have done it sooner but inertia is no joke. We did close the escrow account and are saving the property taxes ourselves and keeping that interest for ourselves as well. We have a 2.75% 30 year fixed and we had been paying an extra 15% of the total monthly mortgage interest + principle payment. But…it’s probably the cheapest money we will ever borrow in our lifetime so no need to pay it off early. Unless we move…but how can you predict that? 1st world problems for sure.
Great article….Power to the SAVERS!!!!
After 60 + years of saving and investing, I just can’t recommend any bond funds at all. Although savings accounts run about 5,0% at this time, it will not last and you will be back at 0.01%, while your bank will
loan out YOUR money at 25%+ – such a deal ! CD’s are not for me. Never will I tie up MY money like that. You need to keep control of your money at all times. if you are too lazy to do that, then suffer the consequences. Banks these days are using every scam they can – payments from your account to a creditor (ie paying your credit card) they take the money immediately out of your account, but do not transmit it to the payee bank for several days- the latter can also hold up crediting their customer’s accountfor a few days. Another scam is telling you it takes a minimum of ten days to transfer money from one bank to another. False! it takes just overnight for such transactions. Some banks have an external processing system which can hold up ALL of your monetary transactions for days. I really think the banks these days are the most criminal elements of our society. Don’t be afraid to contact the Federal authorities when you run into such shenanigans!
0.01%? Really? Rates were never that low in good money market funds or high yield savings accounts. Well, the MMFs got pretty close, but the savings accounts never got much below 1%. While my crystal ball is cloudy, I don’t see rates going back there anytime soon. They could easily be lower than they are right now.
What does “keep control of your money at all times” mean exactly? I mean it sounds good, but are we talking about having it all in cash in your safe at home? Or just in investments where you’re the principal like income properties? So no mutual funds, stocks, bonds etc?