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MMF is yielding just 0.02%, so financial advisors who are still using MMFs as a tool for client cash may be relying on outdated advice.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.

Will we see a return of the Roaring ’20s?

(Originally published in Bond Buyer January 7, 2021)

What more is there to say about 2020? It was a year that brought us the worst public health crisis in more than a century, hundreds of thousands of deaths on U.S. soil, and the agony imposed by lost family members, friends, incomes, and our very way of life. Amidst such a profound human toll, it’s difficult to complain much about the damage inflicted upon our economy, but COVID-19 and its economic impacts will be felt for years and — in some cases — for generations, as family businesses were lost, homes were repossessed, careers were derailed, and breadwinners succumbed to a terrible disease.

In 2020 we witnessed significant market volatility and rapid interest rate cuts reminiscent of the financial crisis. Unemployment levels spiked and supply chains were disrupted. Domestic demand fell precipitously in the wake of lockdowns, oil prices cratered, and equity markets plummeted, only to snap back and reach new all-time highs. Bank balance sheets swelled by 20% in a single year – growing by an astounding $2.7 trillion, while the U.S. dollar was devalued, crypto prices reached new highs, and the gamification of stock trading whipped retail investors into a frenzy.

Who would have ever predicted any one of these events, let alone that they would all occur in a span of 12 months?

How did we get here? 
In an effort to stimulate the U.S. economy and counteract the effects of government-induced lockdowns, in March 2020, the Federal Reserve slashed rates twice in rapid succession, reducing the fed funds rate by a total of 150 basis points. In the most recent Federal Open Market Committee meeting, the Fed indicated they would likely keep rates close to zero for the foreseeable future – experts say at least the next year. While the Fed seems unlikely to cut rates further into negative territory — instead suggesting that fiscal policy is the best tool for further stimulating the economy — the yield curve suggests that low rates are here to stay.

Beyond the Fed’s actions, lower consumer spending and a dearth of good lending opportunities for banks have swelled bank balance sheets, putting further downward pressure on rates. This low rate environment has impacted everything from capital investments, interest rates on loans, mortgages, and savings accounts, and equity valuations. Even cash alternatives — such as money market funds (MMFs), have lost their appeal. Leading government MMFs now yield a paltry 0.02%, and brokerage sweeps even less, typically just 0.01%.

Where do we go from here?
An economic recovery will depend on a resolution of the COVID-19 crisis, enabling a restoration of our consumer-driven economy. Such a recovery has the potential to allow a surge in consumer spending as pent-up demand is unleashed, with the beneficiaries being restaurants, entertainment sources, travel-related businesses and locations, and durable goods. Much as the Roaring ‘20s followed the devastation of World War I and the 1918 influenza pandemic, it’s conceivable that a new period of social liberalization and economic excess could emerge by 2022, leading to inflation and a return to higher interest rates.

Those fortunate enough to have entered this crisis with excess cash on the sidelines may have already profited from the opportunity to follow Warren Buffett’s advice and “be greedy while others are fearful.” Others may have taken the opportunity to build up an emergency fund or a cash cushion to help withstand further shocks to the economy, which could still emerge.

For those holding cash, it’s important to make sure it is earning the most yield possible. Even in a low rate environment, it’s possible to eke out excess returns. For instance, while the average rate paid on savings accounts nationwide is a mere 0.05%, online banks are paying 0.40% to 0.50% on the very same FDIC-insured accounts. Online solutions such as MaxMyInterest can help investors proactively manage their cash and secure rates as high as 0.75% on bank accounts that are FDIC-insured and same-day liquid.

While earning an extra 70+ basis points might not seem like a lot, incremental return without incremental risk is the holy grail in finance. In the same way that investors would happily pick an S&P 500 Index fund that had lower fees, they should similarly seek options for their cash that pay higher returns. This may be the simplest and easiest way to pick up “alpha” in this market, with the simplest and most common asset class of all: cash.

As consumer spending picks up, we should see an increase in loan demand and banks’ wiliness to lend, which in turn should lead to an uptick in bank interest rates that may outpace a steepening yield curve. As a result, we expect the interest rates paid on online savings accounts should continue to outperform MMFs while the economy is rebounding.

Although this past year has been turbulent, to say the least, and interest rates appear range-bound, there is light at the end of the tunnel. Smart investors will position their portfolios to prepare for rising rates and ensure that their cash continues to track the highest interest rates in the market, while remaining ever vigilant for signs of inflation that could impact real returns.

If 2020 was a year most would prefer to forget, and 2022 may well be a year we will never forget, we can all hope that 2021 provides a safe and more sure-footed path to recovery.