In your typical investment account, if you have not chosen to invest the funds you deposited in the account, the cash is invested in what is known as a money market fund. Much like a savings account, these funds earn interest while waiting foryou to make a decision on how to invest. Historically this has been a relatively safe place to hide but given upcoming law changes and the continuation of low interest rates, investors need to be careful not to fall into the money market trap.
Everybody typically has a little bit of money market (cash) in their portfolio and that is fine. Whether dividends or interest have been paid out, a little trading cushion, or for future draws on the portfolio, it is nearly impossible to run an account with no cash. However, sitting on large amounts of money market funds has become more perilous in today’s world than historically.
First is that there is a law change that is being enacted to keep money market accounts up with the current market environment. It used to be that investing in money market was much like putting money into a savings account, put a dollar in, you always can get a dollar out and hopefully earn some interest along the way. However, while it is unlikely, going forward that is not how money markets will work. They will still mostly be incredibly safe but it is now possible for their value to fluctuate and one dollar might not necessarily be one dollar the next day. Now the hope is that the money market funds will not fluctuate much at all but it does mean the selection of the type of money market fund you are invested in because much more important.
Secondly and possibly more importantly, money market funds no longer keep up with inflation. Over the past 30 years, money market would earn you more interest than inflation on average. However, since 2009, this has not been the case and there is little evidence that this trend will reverse anytime soon. Since 2009, if you have been only in money market (cash), you have seen your purchasing power erode by nearly 14% during this time period. Again historically it would have been alright to wait in money market but that is no longer the case as you can see in the chart below.
So what should investor’s do now that money market is not a great place to store wealth? Well first of all, always remember to have a plan. Understand what your wealth is for and when you are planning on using it. Develop your overall asset allocation so that you can invest with confidence and keep money market and cash to a minimum since it is no longer going to keep pace with inflation. Avoid getting stuck in money market for any extended period of time (2 years+). At a minimum consider shorter-term bond funds as a potential alternative to keep pace with inflation.
Low interest rates have made it harder to hide as we have seen not only in money market funds but in places like CDs and savings accounts as well. However just because the investment environment is more difficult, doesn’t mean there isn’t opportunity. Staying diligent and confident to weather short-term volatility has been the secret for investing success for through these past 8 years and my guess is that they will continue to be the secret to success for many more to come. If you feel like you are sitting on too much cash or need help coming up with the right overall asset allocation, never hesitate to reach out to us.