Cash is a great comfort to savers, and that's not going to change overnight. Still, the threat of lower interest rates means now is a good time to lock in yields.
It's unclear when the Federal Reserve will cut interest rates for the first time since its sharp hikes in 2022 and 2023. There's currently a 67% chance that the first cut will come in September, but Fed Chairman Jerome Powell said Tuesday that policymakers need to see inflation calm before taking any action.
Either way, the road down will likely be less steep than the road up. Several rate cuts were predicted late last year in 2024, but that seems unlikely given better-than-expected economic growth. Mark Hamrick, senior economic analyst at Bankrate, said it's likely we'll see “a quick drop in interest rates.”
That gives savers time to prepare and also to rethink the role of cash in their portfolios.With money market funds yielding more than 5%, some investors see little reason to take risks in stocks and bonds. Sure, bonds have been disappointing for a while now. But stocks are up 15% this year, and those who stayed on the sidelines missed out on the AI rally.
Bottom line: Cash is an asset class in its own right and is not a substitute for other asset classes. One option for anxious investors returning to the stock market is the buffer exchange-traded fund. BlackRock recently launched the iShares Large Cap Max Buffer Jun ETF (ticker: MAXJ), which aims to protect investors from market declines instead of limiting their gains. Using a combination of options, the fund aims to track the stock price return of its underlying ETF, the iShares Core S&P 500 (IVV), up to a cap of 10.6% for the first year. At the same time, it offers a 100% downside buffer to protect investors from losses if stock prices fall.
The exact allocation of cash will depend on your stage in life and your goals. Financial advisors typically recommend that working people keep three to six months' worth of living expenses in cash to cover if they lose their job or emergency expenses like car repairs or medical bills. Retirees, on the other hand, should generally consider keeping at least a year's worth of expenses in cash or cash equivalents.
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High-yield savings accounts are a good place to park emergency cash. About 15 of the financial institutions tracked by Bankrate currently boast interest rates of 5.0% or higher. “That's pretty good,” Hamrick says.
To meet their predictable income needs, retirees can build a ladder of fixed-term deposits to lock in today's high yields. A ladder spreads your money across several securities with different maturities, freeing up some cash at regular intervals. Yields on the top 15 five-year CDs tracked by Bankrate currently range from 4.33% to 4.92%. CDs typically impose penalties if you need to withdraw funds early, so a ladder lets you take advantage of today's high interest rates without tying up all your cash.
Eric Gerster, chief investment strategist at AlphaCore Wealth Advisory in Greenwich, Connecticut, recommends including Treasury ladders in his clients' taxable accounts. Income from Treasuries is generally exempt from state and local income taxes, while CD income is taxed at ordinary income rates.
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Retirees who worry that an economic downturn could reduce their income still have time to take steps: “It's a good idea to take some of these steps before the Fed cuts interest rates,” Gerster says.
Contact Elizabeth O'Brien at elizabeth.obrien@barrons.com.