Investors in the U.S. may soon get better returns on idle cash after the Federal Reserve’s latest rate increase. On Wednesday, the Federal Open Market Committee unanimously voted to raise the federal funds rate by a quarter percentage point, taking the target range to 3.75% to 4%. It was the first increase since July 2023.
According to Marguerita Cheng, CEO of Blue Ocean Global Wealth and a member of the CNBC Financial Advisor Council, the move could translate into somewhat higher yields on high-yield savings accounts and certificates of deposit, or CDs. Still, she says the right choice depends not only on headline rates, but also on why the cash is being held, how soon it may be needed and the investor’s tax bracket.
Advisers also warn that nominal yield is only part of the picture. Chris Gunster, head of fixed income at Fidelis Capital, argues that inflation can significantly erode real returns, especially if it continues rising faster than the yields available on money market funds and other short-term instruments. For that reason, he prefers to keep clients’ cash balances relatively low.
T-bills
Gunster says one of the fastest ways to reflect Fed moves is through T-bills, U.S. Treasury securities with maturities of one year or less. He noted that the market had already largely priced in Wednesday’s increase, so yields on bills already in circulation had incorporated much of that move. Investors can buy T-bills on TreasuryDirect.gov with maturities ranging from four to 52 weeks. Earnings are subject to federal taxes, but exempt from state and local taxes.
There are also exchange-traded funds focused on the segment, including the iShares 0-3 month Treasury Bond ETF (SGOV) and the SPDR Bloomberg 1-3 Month T-Bill ETF (BIL).
High-yield savings accounts
Annual percentage yields on high-yield savings accounts are typically linked to the federal funds rate, though other factors can matter too, including a bank’s need for deposits. Each institution sets its own rates.
Bank of America Securities analyst Ebrahim Poonawala wrote on Tuesday that competition for deposits remains intense, but deposit promotions may already reflect expectations for several additional rate hikes. At the same time, these savings rates are variable, meaning investors cannot lock in a return at the moment the Fed raises rates.
Money market funds
Money market funds also track the fed funds rate, but Gunster said they do not adjust immediately after a central bank decision. That means investors may not benefit from higher rates as quickly as they would in T-bills. Even so, he prefers money market funds for client cash holdings.
As of Tuesday, the annualized seven-day yield on the Crane 100 list of the largest taxable money market funds stood at 3.79%. For investors in the highest tax bracket, Gunster says large, high-quality municipal money market funds may be especially attractive because the short-term debt they hold is issued by state and local governments, and the income is exempt from federal income taxes.
CD ladders
CDs allow investors to lock in a rate for a set period, but the money usually must remain in place until maturity and early withdrawals generally trigger a penalty. Cheng recommends avoiding tying up all cash in a single maturity and instead building a ladder, or a mix of several CDs with different end dates.
She said such a structure can be built even with shorter terms, such as six, seven or nine months, staggered over time. That approach gives investors more flexibility while still allowing them to benefit from higher rates.
Floating-rate assets
For investors willing to go a step further in search of income, Cheng says floating-rate funds can also be worth considering. These include funds that hold bank loans and collateralized loan obligations, or CLOs. CLOs are pools of floating-rate loans made to businesses, and their payouts move with short-term interest rates.
Cheng stressed, however, that these instruments are not a direct cash replacement. Rather, she described them as a way to make cash “work a little bit harder.” If the income is not needed, it can be reinvested; if it is needed, investors should remember that it is taxable, though often somewhat higher because it resets regularly.
