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Chris Cyndecki CFA, CFP®

Cash Isn’t King Forever: What Falling Interest Rates Mean for Your Cash

Over the last two years, cash has made a comeback. Yields on high-yield savings accounts, CDs, and money market funds approached 5%. Many investors found these accounts as an appealing, low-risk option for earning returns. However, as short-term interest rates start to decline, cash may lose its shine. Let’s explore why the landscape is changing and how to protect your wealth as the era of high cash returns begins to fade.


The Rise of Cash Yields


In response to skyrocketing inflation in the post-pandemic period, the Federal Reserve began raising the federal funds rate in March 2022 (blue line). The rate increased from 0% in March 2022 to 5.33% in August 2023. 


Interest rates on credit cards, auto loans, home equity loans, and personal loans increased significantly. Yields on savings accounts, CDs, and money market funds increased to the highest levels since 2006. Cash interest vehicles became attractive for the first time in many years. 




The 5.33% federal fund rate was maintained until September 2024. The Federal Reserve began lowering the rate in response to lower inflation levels and favorable employment data. The Federal Reserve is currently expected to gradually reduce the Fed funds rate from now through 2026.  



What Happens When Rates Fall?


As the Federal Reserve continues cutting rates, yields on cash accounts will fall accordingly. While 4-5% yields may have seemed like a good deal recently, it’s unlikely this trend will continue. Over time, we’ll likely see cash yields return to more modest levels. This means cash accounts could offer rates closer to 3% by 2026. 


Here’s the catch: once you account for taxes, the return on these accounts doesn’t keep up with inflation.


After-Tax Yields and Inflation: The Reality Check


One of the most overlooked aspects of cash investment vehicles is how much returns shrink once taxes are taken into account. Interest earned on cash is taxed as ordinary income at your marginal tax rate. This tax hit can sting, especially if you’re a high earner. 


Here is a breakdown of after-tax return, assuming a 3% annualized return on cash. 

Marginal Federal Tax Bracket

After-Tax Yield 

24%

2.28%

32%

2.04%

35%

1.95%

37%

1.89%


Current inflation expectations (FRED 10 Year Breakeven Inflation Rate) are hovering around 2.3% annually. 


We can think of cash as a car tire that recently drove over a small nail. You add air to the tire (interest), but it slowly leaks out throughout the day (inflation & taxes). You soon realize you’ll need to take the car to the tire shop to get it patched.  


While cash can serve as a safety blanket, it offers little in the way of real growth. We’ll need to consider other investment categories to meet long-term goals.


Stocks and Real Estate: Proven Hedges Against Inflation


One of the main risks you will face as a long-term investor is inflation. Your portfolio is intended to cover future living expenses and purchases. In an inflationary environment, prices will increase over time, requiring larger withdrawals from your portfolio. As a result, the portfolio should have exposure to investment categories that perform well during periods of inflation. 


Historically, stocks and real estate have been two of the best ways to protect and grow wealth in an inflationary environment. While both assets come with more risk than a savings account, they also offer a much greater potential for long-term growth.


  1. Stocks: A US stock index (S&P 500) has historically provided returns that exceed inflation by a substantial margin. While stock prices can be volatile in the short term, over long periods (10+ years), stocks tend to deliver positive real returns. For example, the average annual return of the S&P 500 over the last 50 years has been around 10%, far outpacing inflation of approximately 3%. By investing in a diversified portfolio of stocks, you can leverage the growth potential of some of the world’s largest and most successful companies.


  2. Real Estate: Property has also proven to be a reliable asset class for combating inflation. Rents tend to increase in an inflationary environment. Most real estate assets have appreciated in value over time, especially in areas where supply is limited and new construction is difficult. If the hassles of becoming a landlord are not for you, you can invest in diversified real estate through REITs in your brokerage account.


Waiting for An Opportunity 


Many investors sit on cash, waiting for an opportunity to buy stocks during future market declines.


In theory, this seems like a prudent strategy.

In practice, this is extremely difficult to execute. 


Stock Returns are Positive Most of the Time 


From 1926 to 2023, US stocks returns were positive for the year 75% of the time. An investor may be waiting for a long time for a market crash, missing positive returns along the way. 


Buying Stocks during Fear and Uncertainty Isn't Easy


Buying stocks at low prices requires discipline and a lot of intestinal fortitude. A crash in stock prices usually coincides with widespread fear, panic, and uncertainty. During stock crashes, headlines in the media are extremely concerning. Consider the uncertainty at the start of the pandemic when US stock prices dropped 30%. Would you be buying stocks in this environment?     


Legendary investor Peter Lynch once said: “Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves.”


When Cash Makes Sense


Let’s make one thing clear – cash still serves a critical role in your financial plan. You should have cash available for emergencies and any major upcoming expenses. Some studies show healthy cash balances are correlated with overall happiness and life satisfaction.


It’s incredibly important to maintain a cash reserve that allows you to sleep well at night. This cash amount will vary from one household to another. 


However, holding onto too much cash over longer periods creates risk (inflation) and opportunity cost. To move closer to your financial goals, your assets require “real” growth – positive returns over inflation.


The Bottom Line: Cash Isn’t King Forever


The financial world is constantly evolving, and what seems like a good investment today might not look so attractive tomorrow. While cash accounts have offered competitive returns recently, the environment is changing. As interest rates decline, cash yields are expected to fall, and inflation remains a force to consider.


Consider reassessing current cash balances with your financial planner. A primary goal in the financial planning process is monitoring cash levels and determining the right cash balance. If you’ve been holding high levels of cash, or if your savings balances have steadily increased over time, it may be a good time to revisit your priorities and optimize for the long-term. 


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