How rates will continue to impact cash management in 2021

(Originally published in Bond Buyer February 26, 2021)

The Federal Reserve’s response to the COVID-19 pandemic has pushed interest rates to historic lows over the past year.

Changes to the Fed funds target rate and an extensive bond-buying program have driven down rates both at the short and long end of the yield curve. The 10-year Treasury, with a yield that had hovered around 1%, has led to the lowest mortgage rates in memory. A return of the Fed funds overnight rate to a target range of 0 to 25 basis points — a level not seen since the financial crisis — has caused most banks and brokerage firms to cut the rate they pay on cash to as little as 0.01%.

With the Fed targeting an inflation rate of 2%, and with Chairman Jerome Powell’s stated willingness to let inflation exceed that level for a while to make up for past misses, this effectively means that clients sitting on cash are earning a negative real return. And with the average high net worth household keeping 22.1% of its assets in cash, underearning on this asset class can lead to a material drag on overall real returns.

High net worth households keep 22.1% of their assets in cash. Most are dramatically under-earning on this asset class.

Where are we now?

Historically, financial advisors relied on money market funds to manage idle cash that remains in client portfolios. In the current rate environment, this is no longer a good option for clients. The average government MMF is yielding just 0.02%, so financial advisors who are still using MMFs as a tool for client cash may be relying on outdated advice. Similarly, most brokerage sweeps pay just 0.01%, also not an attractive option. Even the average bank savings account offers a paltry 0.04%, according to the FDIC. Simply put, MMFs and regular savings accounts are no longer delivering a compelling yield. A better solution is needed to keep clients on track.

Broker-dealers aren’t faring much better.

Historically, broker-dealers have made the majority of their profit by putting clients in cash sweep accounts that tend to pay almost nothing, lending out the funds at higher rates, and pocketing the spread for themselves. This little-known fact makes stocks and bonds the red herring of the securities industry — most people assume that brokerages make their money from trading commissions, but, in fact, the majority of their profit is earned from knowingly paying clients too little on their cash.

With yields lower and spreads on cash depressed, they’re still profiting from this practice, but not by nearly as much. It’s possible that a prolonged low-rate environment, coupled with recent penalties from the Securities and Exchange Commission for wealth management firms who haven’t put their clients’ interests first, could lead broker-dealers to re-evaluate whether they ought to make available to their clients better, fiduciary-focused options for cash. After all, cash is the beginning of every wealth management relationship as it is the asset that is safe and liquid — and it is often the case that investment relationships begin when clients determine that they have excess cash that could be better invested for the long-term.

Both monetary and fiscal policy must also be considered.

With the pace at which the U.S. government is printing money, inflation seems all but inevitable. Our national debt has risen by more than 40% in the past four years, and as we begin to recover from the pandemic, inflation could become more apparent in consumer prices.

It is also essential to keep in mind that those who have been fortunate enough to save during the last 12 months are sitting on cash and will be looking to spend or invest it once lockdown protocols ease up. Against that backdrop, cash that’s earning 1 or 2 basis points in a brokerage sweep or MMF is actually losing value each year.

Where do we go from here?

Now would seem to be an opportune time for financial advisors to reconsider how they are talking to their clients about cash.

Many registered investment advisors, who are bound by a fiduciary standard, are beginning to treat cash like any other asset class and are looking to maximize returns for clients.

One of the simplest ways to do this is to turn to more innovative solutions to manage client cash that put clients’ interests first. Run-of-the-mill savings accounts at online banks yield up to 0.50%, while MaxMyInterest helps clients earn yields of up to 0.75% on same-day liquid, FDIC-insured deposits, held directly in the clients’ own name.

It’s no wonder that leading advisor tools such as OrionEnvestnet | MoneyGuideMorningstar, and Redtail are integrating with better cash solutions that can help clients earn more on cash in their own FDIC-insured accounts.

As advisors seek to find yield for their clients, it may also be appropriate to look at less conventional yield-producing assets that may be less correlated with the market, such as produce anticipation loans, to help clients pick up extra yield.

A barbell strategy of cash plus longer-dated higher-risk assets can help clients pick up yield without sacrificing liquidity.

Many investors have also been seeking yield from dividends on the S&P 500, a trade that worked well in recent years since it offers a 2% yield with plenty of liquidity and a built-in inflation hedge.

However, anything other than cash in a client’s bank account adds risk. Looking at the risk-reward continuum across fixed-income instruments, you’d have to go more than 5 years out on the Treasury curve before you could match the yield available in FDIC-insured savings accounts.

Now is an opportune time for advisors to engage with their clients on the topic of cash and deliver better returns. You just need to know where to look.

5 Finance Tips for New Parents

5 Finance Tips for New Parents

Some decisions you make now can affect your family’s financial picture for decades.

Expecting a baby? You will have probably prepared for the initial expenses, like a good baby swing and the reams of nappies you’ll need, but will you want your newborn to go to college someday? It sounds premature to begin thinking about tuition now, but it’s just good financial planning. Some decisions you make now, before your baby is born or while you still have a tiny newborn, can affect your family’s financial picture for decades. Here are five finance tips for new parents:

1. Set up a 529 plan

A 529 plan account allows you to set aside money for college, graduate school, and other educational expenses while gaining substantial tax advantages. The accounts can be used for the named beneficiary — your baby — as well as any siblings or descendants, so you won’t lose the money if your child grows up to be a rock star or professional athlete and never goes to college. Because of the power of compounding, money that you contribute at birth for your child’s higher education will grow over time, tax-free. If you add funds regularly — many plans offer automatic deductions that let you contribute a set amount each month from your savings accounts — you could set aside a significant portion of your child’s tuition money by the time college comes around. Then, you can help them attend whatever college they like and teach them about how Credit Cards to Build Credit and how to use money efficiently whilst they’re away. Your planning and preparation can help them be financially stable whilst at college. Shop around for the best plans; each state has different rules. Consider choosing a plan that doesn’t require your child to attend college in a particular state, because you can’t know where your family will be living by then or what your child will prefer. Because of the tax advantages, it’s often worth your time to set up such a plan even if you don’t think you’ll have trouble funding your child’s tuition. The first $10,000 contributed each year is typically state tax deductible, so for someone living in a high tax state like New York or California, that could translate into a $1,000 savings on your state tax bill each year. Not many other investments provide for a 10% gain on day one, and when combined with the fact that your 529 contributions grow tax-free, it’s obvious why establishing a 529 plan in the year that your child is born can be a wise finance move for new parents.

2. Set up baby’s first bank account

Relatives may choose to give your child money as a baby gift. Consider setting up a savings account in the child’s name or in trust for the child. You can choose your own bank, or select the one with the best interest rates, since your child likely won’t be using this money for years. Credit unions and online banks typically offer the best rates — which matter since you’re planning for many decades of compounding. CapitalOne 360 offers online accounts for children that pay 0.75% in interest, and recently offered a promotion that funds the first $30 when parents set up an account for a minor.

3. Register for airline frequent-flier numbers

As soon as you start buying a separate airline seat for your baby — you’re not required to do this until age 2, but you may want to start earlier so the baby can sit in a car seat on the plane — sign up for frequent flier numbers on the airlines you fly most often. Just like an adult, a child of any age can amass airline rewards points to earn status while flying. Even if your baby isn’t a global traveller, this is important in oversold situations — air miles members are treated better than those without a frequent flyer number on file. Also consider applying for a passport in infancy, in case your family wants to travel overseas. Even if your child can’t hold his or her head up yet, passport photos can be taken at home by lying your baby down on a white blanket, snapping a head-and-shoulders photo, and taking the memory card to your local photo store, where they can convert the file to passport-sized photos.

4. Add your baby as a beneficiary on your documents

The fourth finance tip is to check with your lawyer to make sure your baby is named in your will — or at least that you’ve put in a provision for your direct descendants without naming them. Also make certain you’ve added your baby as a beneficiary on all your legal and financial documents: bank accounts, 401(k)s and IRAs, pensions, life insurance, and anything else with value.

5. Set up an email address

Who knows if we’ll be using email by the time your baby is old enough to type. Just in case, new parents should sign up for a free email account with a popular service like Google’s Gmail. Try to get the baby’s name (Joseph.William.Smith@gmail.com) if possible, but don’t put into the account name itself any details that you’ll want to keep secret, like the baby’s birthdate. Email accounts are a necessity for virtually all online services, including bank accounts. Once the email address is set up, you can also cc: your child’s email address whenever emailing family photos, creating a permanent storehouse for your baby that he or she will enjoy later on.