Many investors want to keep a portion of their portfolios in cash or cash alternatives, such as a money market mutual fund or certificate of deposit. When allocating to these cash alternatives, it’s important to understand the role cash plays in a portfolio and to have a perspective on the outlook for short-term interest rates.
The Federal Reserve sets the federal funds rate, which is the interest rate banks and other depository institutions use to lend money to each other overnight. When the federal funds rate is low, the interest rate offered on money market mutual funds and CDs tends to remain low. In December 2015, the Federal Reserve increased rates for the first time in almost 10 years. In March 2016, Federal Reserve Chair Janet Yellen said, “Given the risks to the outlook, I consider it appropriate for the Committee to proceed cautiously in adjusting policy.” In other words, the federal funds rate may remain at comparatively low levels for some time.
CDs are time deposits offered by banks, thrift institutions, and credit unions. They may offer a slightly higher return than a traditional bank savings account, but they also may require a higher amount of deposit. With a CD, your principal is locked. If interest rates rise, you may not be able to take advantage of the higher rates until the CD matures. An early withdrawal penalty may apply. Bank savings accounts and CDs are FDIC insured up to $250,000 per depositor, per institution.
Money market funds typically pay dividends, which may be greater than the interest rate offered by bank savings accounts or CDs. Money market funds seek to preserve the value of your investment at $1.00 a share. Money held in money market funds is not insured or guaranteed by the FDIC or any other government agency. It’s possible to lose money by investing in a money market fund.
Mutual funds are sold by prospectus. Please consider the charges, risks, expenses, and investment objectives carefully before investing. A prospectus containing this and other information about the investment company can be obtained from your financial professional. Read it carefully before you invest or send money. Past performance does not guarantee future results. Actual results will vary.
Source: Thomson Reuters, 2016. For the 20–year period between Jan. 1, 1996, to Dec. 31, 2015.