Make Cash Pay Its Way

8/28/2023

For the first time in decades, cash yields are close to the earnings yield of the U.S. stock market. Both are currently about 5%. Historically, earnings yields of equities have been meaningfully higher than those of cash. That makes sense, given the relative risks of investing in equities.

The current relatively high yield on cash might help investors be more patient when considering buying riskier assets. Over most of the last fifteen years prior, the opposite was true; ultra-low yields on cash prompted many investors to look elsewhere to find more yield, which inevitably meant taking more risk.  The latter topsy-turvy situation was driven by the Federal Reserve’s policy to hold rates low, in part to encourage investment in risk assets. Today, cash is back on its throne.

But what is cash?

When we hold cash in a brokerage or bank account beyond intraday, it is not really cash in any meaningful sense. Each night, cash is ‘swept’ into either a money market fund or a bank product. Those two products are often referred to as sweep vehicles.

A money market fund is a mutual fund that is governed by specific regulations for this type of fund. The rules cover the types, liquidity, and maturities of securities that can be held. Investments are made in areas such as very short-term commercial paper, Treasuries, or munis. The nature of the investments depends on the fund’s objective. This means that not all money market funds are created equal. Each needs to be understood before making an investment.

By comparison, a bank product is an obligation of the bank and earns only what the bank chooses to pay.  The ‘investment’ is a liability of a bank owed to you.

These distinctions are important. Yields can vary dramatically. Given money market funds earn a rate based on their market investments, their yields will fluctuate with the market. When market rates go up, the yield rises too. Meanwhile, the banks decide what to pay on their products. If a bank is focused on its profitability, it will be tempted to keep rates low. Currently, banks offer very low yields for their sweep vehicles.  Those yields are a fraction of the return available in money market funds.

But there is more. In addition to sweep money market funds, there are ‘position-traded’ money market funds.  Whereas sweeps occur automatically, these position-traded funds must be purchased. The benefit of that extra work is that they offer a higher yield than sweep funds. The highest yields also have high minimums, which could be $1 million or even higher. Schwab currently offers 18 options for holding cash, 17 of which are position-traded money market funds.

So, cash may be crowned and sceptered right now, but we must take time to keep it hard at work. Life in a bank sweep is way too easy. Moving to a position traded money market fund can make the same cash ten times more productive.

Jeff Buck