Investors with cash are getting a nice yield, but that attractive income is about to run out. Money market fund assets hit $6.14 trillion as of the week ending July 24, according to the Investment Company Association. Can you blame investors for hoarding cash in these accounts? The largest money market fund has an annualized seven-day current yield of 5.12%, according to the Crane 100 Money Fund Index. The bad news is that, according to the CME FedWatch tool, federal funds futures trading data indicates that there is a 100% chance that the Federal Reserve will ease interest rate policy in September. If that happens, cash yields will plummet. Financial advisors and asset managers recommend that investors add duration, or exposure to longer-term debt that is more price-sensitive to interest rate movements, through municipal bonds and other fixed income securities. That way, they can lock in today’s high yields and benefit from rising prices, as bond prices and yields move in opposite directions to each other.But not everyone is ready to commit to longer maturities, so a gradual step to increase duration could be to move some money into shorter-term bonds. “A significant number of money-market investors may feel like now is the right time to gradually take on more risk, but they shouldn’t let their guard down completely,” Daniel Silk, head of global short-term duration and liquidity at Janus Henderson, said in a report earlier this month. “For investors who prioritize low volatility, visibility, and a degree of capital appreciation that money markets don’t provide, the logical destination along the risk spectrum would be fixed income—the front end of the yield curve and the higher-quality corporate credits there,” he said. A Stepping Stone to Duration Looking out through mid-2025, Matthew Misch, head of credit strategy at UBS, sees total returns of 7.1% for investment-grade bonds with maturities of 7 to 10 years, and about 4.8% for money-market funds. But adding exposure to bonds with maturities of one to three years can also offer advantages over cash, Silk said. These bonds offer yields with lower interest rate risk compared to longer-term instruments and offer some capital appreciation amid falling interest rates. “Investors should also remember that the maturities of highly liquid securities held in money market funds are limited to just over one year,” he said. “If interest rates fall, this year’s attractive yields will not carry over to next year.” “In contrast, exposure to bonds with a maturity of one to three years means that today’s yields are more durable if you hold the securities to maturity,” Silk added. Investors dipping their toes into these shorter-term bonds should aim for quality by going for investment-grade bonds rather than dabbling in high-yield bonds, he said. Combining yield and price appreciation Investors may want to consider exchange-traded funds that offer exposure to a basket of short-term bonds. Keep in mind the credit quality of the underlying assets and fees, though, as high fund expenses will erode returns over time. The Vanguard Short Term Corporate Bond ETF (VCSH) has a 30-day SEC yield of 5.1% and an expense ratio of 0.04%. The fund has a strong bias towards investment grade bonds, with 45.2% of the allocation in BBB-rated bonds and 46.9% in A-rated bonds. There is also the iShares Short Term Government Bond ETF (SHV), which has a total expense ratio of 0.15% and a 30-day SEC yield of 5.12%. While these short-term bonds may be an attractive alternative to stashing them in cash, investors should avoid making short-term bonds the majority of their bond holdings. Because while these yields may not fall as quickly as cash yields, they certainly will in a falling interest rate environment, which could affect a portfolio’s income generating ability over the long term. A diversified portfolio includes exposure to a variety of maturities along the yield curve, allowing investors to capture income and price appreciation while offsetting equity volatility.
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