When To Use CDs, High-Yield Savings Accounts, Money Market Funds And Cash
I recently spoke with a young woman whose goal is to purchase a home in 15 years. She received advice from her friends to place money toward that goal into a high-yield savings account.
She’s not the only young person I’ve seen to consider ultra-conservative investments for long-term goals. In the past couple years, many investors have turned to certificates of deposit, high-yield savings accounts, money market accounts, short-term treasuries, and other very conservative investments for a wide range of far-off goals.
While all these investments could be preferable to stuffing dollars under your mattress, they may not be the most efficient vehicles for long-term goals. Let’s discuss ultra conservative investments, why people are in them, where they’re useful, and where other types of investments may serve you better.
Why People Are In Ultra-Conservative Investments
Here are some reasons investors choose to keep more than three to six months of emergency reserves in cash and cash alternatives:
They have a near-term cash need.
They are afraid of the stock market.
They don’t understand the basics of investing.
They are attempting to time the stock market.
They are not sure what their financial goals are.
From an investment and returns standpoint, reasons two through five are not good reasons to be in ultra-conservative investments. Only a near-term cash need would be a valid reason from a purely logical perspective.
When Ultra-Conservative Investments Are Effective
If you’re buying a house, buying a car, funding a wedding, paying for college, or have any other large lump sum need in the next three years, then ultra-conservative investments like high-yield savings, CDs, money market accounts, and short-term treasuries may make a lot of sense. You’d have liquidity by the specified date of your choosing and receive modest returns.
These types of investments are also effective in an emergency fund for the same reasons. If you do not have a near-term cash need and you are holding greater than six months of expenses in emergency reserves, it may be time to investigate other strategies.
When Ultra-Conservative Investments Are Not Effective
If you are saving for an intermediate to long-term goal (you have more than three years), ultra-conservative investments tend not to be as effective as other traditional investments.
Consider Stocks For The Long Run
If you invested $1 in U.S. Treasury Bills (short-term debt backed by the U.S. Government) in 1926, you would have $22 today. When you see that, you might think, “hey, 22 times my money isn’t so bad over almost 100 years.” That is true, until you compare those returns with the stock market.
Stocks are ownership stakes in companies. In this discussion, I’m assuming investors are not picking individual stocks, but investing in diversified bundles of stocks, known as funds. If you invested $1 in a large company index in 1926, you’d have $11,527 today and you’d have about 2.5 times that number if you invested in a small company index.
True, not everyone has nearly a 100-year time horizon. So, let’s look at shorter periods. If you look at 30-year periods in the S&P 500, the average annualized return has never been lower than 7.8%.
There were some 10-year periods where people were better off with cash than the S&P 500— like the Lost Decade, which started toward the top of the doot-com bubble on Dec. 31, 1999 and ended toward the bottom of the housing crisis on Dec. 31, 2009. But you shouldn’t just be investing in the S&P 500 when you’re investing. A small company index returned 74.4% during that same period. Investors who have some time and broadly diversified stock portfolios could end up with many more assets than their conservative counterparts.
Bonds And Creating Income
Bonds are considered conservative investments but even they have a lot more firepower to get people to their investment goals than the ultra-conservative investments we’ve discussed. At their core, bonds are debt instruments. You are lending an organization money over a specified period and in return, you are paid interest until the money you lent is paid back in full. Many bond investors also choose to diversify these debt interests by investing in funds that hold and manage many bonds. A 100% bond investor would have had an average rate of return of 6.3% from 1926 to 2021.
While bond funds can come with several risks, including interest rate, reinvestment, default, and inflation risk, they can be effective at creating income without investors needing to dip into their original investment. For this reason, many retirees have a significant portion of their retirement assets in bonds.
Conclusion
While cash, cash alternatives, and other very conservative investments have their place in your financial plan, you should think critically about your financial goals before allocating more than your short-term cash needs to these types of investments. Investing involves risk, but with a diversified portfolio, greater risks are usually rewarded with greater returns. Consider speaking with a qualified financial professional about your goals and risk tolerance to see which other types of investments may be appropriate for you.
This was originally published by me on Forbes.
This informational and educational article does not offer or constitute, and should not be relied upon as, tax or financial advice. Your unique needs, goals and circumstances require the individualized attention of your own tax and financial professionals whose advice and services will prevail over any information provided in this article. Equitable Advisors, LLC and its associates and affiliates do not provide tax or legal advice or services. Equitable Advisors, LLC (Equitable Financial Advisors in MI and TN) and its affiliates do not endorse, approve or make any representations as to the accuracy, completeness or appropriateness of any part of any content linked to from this article. Past performance is not indicative of future results. Individual investor results will vary. Asset Allocation, which is a method of diversification that positions assets among major investment categories, does not guarantee a profit or protection against a loss. CDs are FDIC insured. Indices are unmanaged portfolios of specified securities. Individuals cannot invest directly in an index. Funds that invest in bonds are subject to interest rate risk and can lose principal value when interest rates rise. Investments in large-capitalization companies may involve the risk that larger more established companies may be unable to respond quickly to new competitive challenges. Investments in mid-capitalization companies are generally less established and their stocks may be more volatile and less liquid than the securities of larger companies. Investments in small-capitalization companies may be more vulnerable to adverse business or market developments than larger capitalization companies.
Cicely Jones (CA Insurance Lic. #: 0K81625) offers securities through Equitable Advisors, LLC (NY, NY 212-314-4600), member FINRA, SIPC (Equitable Financial Advisors in MI & TN) and offers annuity and insurance products through Equitable Network, LLC, which conducts business in California as Equitable Network Insurance Agency of California, LLC). Financial Professionals may transact business and/or respond to inquiries only in state(s) in which they are properly qualified. Any compensation that Ms. Jones may receive for the publication of this article is earned separate from, and entirely outside of her capacities with, Equitable Advisors, LLC and Equitable Network, LLC (Equitable Network Insurance Agency of California, LLC). AGE-6225608.1 (1/24)(Exp. 1/26)
