Investment advisors are now recommending that clients reconsider large cash positions as the Federal Reserve begins its anticipated easing of interest rates.
With this shift, money-market funds, which have seen massive inflows, may soon lose their attractiveness, prompting investors to seek alternative options with greater risk.
Money-market funds boom since 2022: will the trend continue?
Retail money-market funds attracted a staggering $951 billion in inflows since the Fed kicked off its rate-hiking campaign in 2022 to curb inflation, according to the Investment Company Institute, an organization representing investment funds.
By September 18, 2023, total assets in these funds surged to $2.6 trillion, marking an 80% increase since early 2022.
However, with the Federal Reserve now reversing course and lowering rates, the appeal of these ultra-low-risk investments may be short-lived.
“As policy rates fall, the appeal of money-market funds will wane,” Daniel Morris, Chief Market Strategist at BNP Paribas Asset Management, told Reuters.
Fed rate cut signals a shift in investment strategy
On Wednesday, the Federal Reserve cut the federal funds rate by a significant 50 basis points, bringing it down to a range of 4.75% to 5%.
This sizable reduction may push investors to reassess cash holdings and other low-risk assets as returns dwindle.
Jason Britton, founder of Reflection Asset Management, overseeing $5 billion in assets, advises that investors will need to accept more risk.
Britton emphasized the need for higher-risk strategies, adding:
Money-market assets will have to become fixed-income holdings; fixed income will move into preferred stocks or dividend-paying stocks.
Seeking higher returns amid falling rates
Money-market funds, which primarily invest in short-term government securities, have long been attractive due to their risk-free returns.
When interest rates rise, so do their returns, drawing investors seeking safety. But now, with rates declining, their shine may start to fade.
In the same Reuters report, Ross Mayfield, investment strategist at Baird Wealth, suggests investors re-evaluate their portfolios.
If you’re relying on income from money-market funds, you may need to consider longer-term investments to lock in rates and protect yourself from falling interest rates.
Despite the shifting landscape, some experts, like Carol Schleif, Chief Investment Officer at BMO Family Office, believe there’s still value in holding cash to seize future stock-buying opportunities.
Although analysts suggest it may take a week or longer for the market to fully react to the Fed’s decision, the Investment Company Institute’s latest report shows money-market fund flows have remained stable.
Retail investors, however, have been hesitant to abandon their cash holdings entirely, according to advisors.
Investors face tough choices
As interest rates fall, clients are increasingly eager to find alternatives to cash, says Christian Salomone, Chief Investment Officer at Ballast Rock Private Wealth.
Yet, Jason Britton warns that “investors are stuck between a rock and a hard place,” faced with either taking on more risk or settling for lower returns in cash-like investments.
With the Fed’s rate-cutting cycle just beginning, the months ahead will likely see a reallocation of assets, as investors adjust to the new economic reality.
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