With the Federal Reserve recently stating it expects short-term rates to remain at these microscopic levels for another two or more years, why would anyone park money in cash or money market funds?
I can think of two good reasons.
First reason: It can cushion the blow and keep you from freaking out when the stock market crashes. We all know not to sell low, but let’s admit it — we let fear take over when things look bleak.
The coronavirus crash is just the latest in a long string of temporary market crashes driving people to sell, apparently having lost faith in their plans and in the future of the way society works.
They may even utter those four costliest of words: “This time, it’s different.”
Never underestimate how helpful cash can be in these situations. It’s comforting to see at least one investment in your portfolio maintaining its value when everything else craters.
If you can keep your cool with 100% invested in stocks, more power to you.
Traditionally, investors have used bonds to counter stocks’ movements, but note that it’s not uncommon for bonds and bond funds to go down during large stock market drops.
Granted, bonds typically don’t go down as much as stocks, but if you have one investment going down less than another, it won’t have the same impact emotionally.
And if you buy longer-term bonds to earn a little more interest, you take on the risk of significant principal drops if interest rates go up. (Most bond prices move in opposite direction of interest rates.)
The second reason: Planned withdrawals.
Since we don’t know when the next stock market drops will happen, it is a good idea to have other investments available to draw from during periods when stocks are low. That way, your stocks have a chance to recover while you draw on your cash reserve.
When holding cash or money market funds as part of a portfolio, be careful not to become disillusioned during stronger periods in the stock markets when cash may feel like dead weight.
Think of cash as a just-in-case investment.