Many on Wall Street are warning that investors may need to reconsider their cash allocation heading into 2025. Yields on cash-equivalent investments such as money market funds, certificates of deposit, and Treasury bills follow movements in Federal Reserve interest rates. The central bank is widely expected to meet next week and cut rates by another quarter of a percentage point, bringing the federal funds rate to 4.25% to 4.5%. Despite falling yields, Americans' love affair with cash doesn't seem to be waning anytime soon. A record $6.77 trillion was held in money market funds as of the week ending Dec. 4, according to the Investment Company Institute. That's nearly $5 trillion more than money markets held in September, before the Fed cut interest rates for the first time in four years, followed by another cut in November. Peter Crane, founder of Crane Data, a firm that tracks money markets, said that even though yields on money market funds have fallen, investors should continue to take assets out of low-yielding bank deposits. His Crane 100 Money Fund Index is based on the largest taxable money funds and had an annualized seven-day yield of more than 5% earlier this year. It has since fallen to 4.43% as of Wednesday. Crane expects yields to rise above 4% heading into next year and 3.5% by 2025. “As short-term interest rates remain attractive in both nominal and real terms, money funds continue to benefit from their strongest attribute, market returns,” he said. It's unclear what the Fed will do with interest rates next year. Inflation is well below its 2022 high, but has started rising again in recent months. The Consumer Price Index accelerated to a 12-month rate of increase of 2.7% in November, still above the central bank's 2% target, according to the Bureau of Labor Statistics. Additionally, wages remain strong, and there are concerns that President-elect Donald Trump's policies will push up prices. Vanguard expects inflation to remain above 2% through 2025 due to “stickiness” in housing and services inflation. The asset manager, which manages more than $9 trillion in assets, predicts the federal funds rate will fall to 4% by the end of next year. However, if inflation recovers, the central bank will need to slow its pace of easing or even reverse course and raise rates, the bank said in its 2025 outlook. “The era of healthy money, characterized by positive real interest rates, is here to stay, laying the foundation for solid cash and bond returns over the next decade,” the Vanguard team wrote. Cash lags other assets With yields at their highest in years and a backdrop of inflation and economic uncertainty, people are putting their excess cash into money markets, certificates of deposit, high-yield savings accounts, No wonder they keep their money in Treasury securities. A July Empower survey found that 49% of Americans feel safer holding cash than other investments. The financial services company surveyed 1,009 U.S. adults. According to Empower, cash accounts for more than 27% of users' portfolios. But Luis Alvarado, global fixed income strategist at Wells Fargo Investment Institute, says that as a general rule of thumb, keep only 3% to 5% of your portfolio in cash for emergencies and other liquid needs. He said it should be kept. “If you look at the historical evidence, cash as an asset class lags very significantly over time,” he said. In fact, he noted, the S&P 500's cumulative return from July 30 to December 11, 2023 was 35.5%. Money market funds with a 12-month yield of about 5% returned an average of about 7.34% over the same period, Alvarado said. He used the Morningstar US Fund's money market taxable category as a proxy. UBS also warned of poor cache performance. Mark Hefele, chief investment officer at UBS Global Wealth Management, said in the bank's 2025 outlook that “real cash returns have been dismal in recent years and rising interest rates have not been enough to offset soaring inflation.” said. Since the beginning of this decade, the real purchasing power of cash has fallen by 8% in US dollar terms, he said. “We expect cash to continue to be one of the worst performing major asset classes,” Höfele added. “An interest rate cut cycle is underway, undermining future cash returns.Meanwhile, secular trends such as deglobalization, decarbonization, rising debt, and an aging population are putting periodic upward pressure on inflation. Similar to timing the market, John Queen, a fixed income portfolio manager at Capital Group, said cash could be “attractive.'' He likened it to the legal concept of “nuisance.” “It's something that attracts people, but it's actually dangerous,” he says. He explained that by the time people noticed the drop in cash yields, bonds had already gone up, and they were missing out on an opportunity to lock in attractive yields. “Having cash makes you a market timer, but no one is a better market timer,” he said. “Cash is a trap for most people.'' Fixed income An investor's portfolio should be tailored to their time horizon and risk profile, Queen said. He said core bonds make up a significant portion of the fixed income position. The asset manager also sees opportunities in structured credit as well as parts of the commercial mortgage-backed securities and auto asset-backed securities markets. Wells Fargo Investment Group said in its 2025 investment outlook that it favors extended maturities, first with intermediate durations (3 to 7 years), then longer maturities, and then even shorter bond ladder strategies. . “Investors consider this ordering when purchasing new bonds, repositioning maturing securities, and reallocating among their chosen managers to achieve this ladder. “can be done,” the team wrote. Income investors can also focus on high-dividend stocks. “Large U.S. companies have accumulated more than $2.4 trillion in cash on their balance sheets and may choose to begin paying or increasing their dividends,” Wells Fargo said. UBS also advises investors to move excess cash into assets that offer higher levels and more durable income streams. He said the risk-reward profile of investment grade (IG) corporate bonds is favorable, even though the assets are expensive compared to U.S. Treasuries. “In a portfolio context, IG bonds can be complemented with riskier credits (such as US, euro, and Asian high yield bonds, emerging market bonds, and senior loans) to improve diversification and increase returns. “I think so,” Haefele said. “We recommend that investors managing single-bond portfolios focus primarily on high-quality bonds, with the addition of selective investments in short-term and intermediate-term risky credits,” he added.
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