By Dr. Jim Dahle, WCI Founder
I fully understand that high(er) interest rates are not good for everyone. Mortgage rates are now around 7%-8%. 2023-2024 federal medical student loans are at 7.05% and 8.05%. The cost of borrowing has gone up for every business and every individual. Higher rates aren’t necessarily even good for my overall finances (the WCI student loan refinancing product line has been predictably decimated). However, unlike the last 20 years, it sure is nice to finally feel like I’m not being punished for being a relatively debt-averse net saver.
Positive Real Returns on Cash
As I write this post on September 6, 2023, my chosen cash holding (The Vanguard Federal Money Market Fund) has a seven-day SEC yield of 5.27%. That’s the highest it has ever been since I became an investor with my first paychecks way back in 2003 (it was close in 2007 before rates were cut in response to the global financial crisis). Meanwhile, inflation as measured by CPI-U is at 3.18%. Thus, cash has a real (after-inflation) return of over 2%. That’s remarkable to this investor and pretty exciting. Yes, it’s still not an awesome return for ME after-tax ([1 – 37% -4.85% – 3.8%] × 5.27% = 2.86% nominal), but the more volatile Vanguard Municipal Money Market Fund is paying 3.90% for those of us with high marginal tax rates and a willingness to monitor rates frequently. That still provides a positive real, after-tax return.
The yield curve is also still inverted
with five-year, 10-year, and even 30-year Treasuries yielding less than T-bills.
There are several benefits of this environment, and you should take advantage of them.
#1 No Rush to Invest
Perhaps the greatest benefit of earning 2% real without taking any risk is that I no longer feel a big rush to get my money “working for me” as quickly as possible. Yes, I need to get it out of my checking account(s) and into that money market fund. But once it’s there, I have plenty of time to do “investing chores” and to wait for the right opportunity (as far as illiquid investments go).
#2 Easy Short-Term Savings Decision
Most of us have at least some short-term savings decisions. For me right now, it’s my new truck and my quarterly estimated tax payment. When rates were low (and especially when real rates were negative), we all had a difficult decision to make with our short-term savings. Do we take on a little risk in the hope of a little more return? No need to bother anymore. Just plunk it into your cash account and quit worrying about it. In the short run, cash has a higher expected return than any bonds, and you weren’t going to take on equity risk anyway.
#3 No Cost to an Emergency Fund
When talking about your emergency money, the (rapid) return of your principal matters more than the return on your principal. However, there is usually a cost to having that “insurance”—the cost being a relatively poor return. Well, no more. Now, you can earn 5%+ on your emergency fund. So, WHY NOT have one? “Free” insurance.
More information here:
#4 Higher Expected Returns on All Assets
Yes, when interest rates go up, the value of your stocks, real estate, and bonds (especially bonds) typically falls. However, savvy investors also realize that FUTURE returns on those same assets just went up. Maybe your bond fund with a duration of five years fell 10% in value as rates went up 2%. But it also yields 2% more, and since the best guess of future returns is the current yield, your expected return just went up 2%. In fact, after five years, you’ll actually be ahead with higher rates.
While not as obvious, the same thing applies to stocks and real estate. Yes, the cap rate went up on that investment property, and its value fell. But (all else being equal) higher cap rates mean a higher rate of return on the current value. Plus, if rates fall in the future, you’ll get a “kicker” on that return as the property goes up in value. Stocks also must (theoretically) provide higher returns. Why would someone accept 2% real returns on stocks when they can get that on cash?
#5 Easy Decision When Carrying Low-Interest Rate Debt
When interest rates on cash are low and you’re carrying 2%-3% debt, you wonder if maybe you should just pay it off. When you can get 5%+ on cash, that decision becomes really easy. Sure, you may still decide to get rid of the debt for cash flow and/or psychological reasons, but there are no tough math/risk decisions to make.
More information here:
High(er) interest rates have their pluses and minuses. You might as well take advantage of the pluses.
What do you think? What benefits are you enjoying from the increased rates on cash? Where is your cash right now? Comment below!