Savers rejoice! There’s an upshot to some of this year’s steep market declines: you can now earn a decent yield on cash. With the U.S. Federal Reserve (the Fed) continuing its mission to squash inflation via higher interest rates, short-term yields have swiftly risen from near zero this time a year ago to now the loftiest levels in nearly 15 years.
The U.S. 1-year Treasury bill (T-bill) currently boasts a yield above 4%. While that amount is far below the current headline Consumer Price Index (CPI) rate of 8.3%, it’s significantly above the expected inflation rate over the coming 12 months.
Traders often point to the latest yield on Treasury Inflation-Protected Securities (TIPS) as a gauge of what the future holds for inflation. We can do a little math to figure out where the market sees inflation over the coming year. Currently, the 1-year TIPS rate is about 1.96%. Since the yield-to-maturity (YTM) on a 1-year T-bill is 4.14%, the difference is the implied inflation rate: 2.18%. That means owning short-dated Treasuries could mean beating inflation by almost two percentage points over the coming 12 months.
So-called “inflation swaps” suggest tamer inflation in the year ahead – a 1-year inflation swap shows a higher expected rate of 2.7%, still a far cry from this past year’s 8.3% reading. What a difference a year might make!
Where to park your cash
While it’s fun to geek out with Treasury securities and inflation data, let’s figure out the best places to stash your cash. One of the easiest ways to gain exposure to Treasury bills and notes is through an exchange-traded fund (ETF).
A popular Treasury ETF, now the biggest in terms of total assets at more than $25 billion, is the iShares 1-3 year Treasury Bond ETF (SHY). According to iShares, as of Sept. 21, SHY’s average YTM, a measure of a fund’s current yield, is 4.08%. It costs just 0.15% per year to own. The most recent dividend was just $0.10, but new higher-yielding securities will result in bigger dividends in the months ahead. It’s also important to know that T-bills are issued at a discount from face value, so price appreciation is a component of the holdings’ return.
Another option is the Vanguard Short-Term Treasury ETF (VGSH) which also invests in Treasuries maturing in 1 to 3 years, but it sports a lower expense ratio of just 0.04% annually.
Understand the risk
Keep in mind that there is what’s known as “interest rate risk” with bond funds. When market rates rise, the price of a bond drops. It’s like a seesaw. Given the massive fixed-income market selloff over the last year, SHY, for instance, has a negative 5.1% return including dividends.
So, you can lose money with bond ETFs – if rates rise and you then sell, a capital loss results. You will, though, still receive dividend income whether the fund’s price goes up or down. Even with that risk, a YTM of 4% is enticing.
Money market rates jumping
An even simpler vehicle to capture a decent interest rate is simply parking cash in a money market mutual fund.
After this week’s 0.75 percentage point rate hike by the Fed, many of these funds yield above 2%. Money market mutual funds aim to keep a $1 share price, so barring a cataclysmic event, you likely won’t see your principal balance fluctuate as you would with, say, a short-term Treasury ETF.
What’s more, Chair Powell has made it clear that even higher interest rates are on the way, so that means money market funds could yield above 4% in 2023. We haven’t seen that since the mid-2000s.
Treasuries over stocks? Not so fast
A sudden surge in safe yields offered through the Treasury market has some analysts claiming that there is, at long last, a solid alternative to stocks. Pundits sometimes point to the yield on T-bills or the 2-year note when assessing the yield you might get on the S&P 500 or a dividend fund. That’s sort of an apples-to-oranges approach since a single day’s decline can wipe out a year’s worth of dividends on a stock or equity index fund. So, the yield on a Treasury is a whole different animal than a stock’s yield.
Moving a portion of your portfolio from stocks to short-dated Treasuries is never one-size-fits-all and any move should be carefully considered. Keep in mind that many parts of the stock market are cheaper today than a year ago given the steep declines we’ve all experienced.
A savvier move might be to simply ensure that cash in your account, perhaps your emergency fund, is earning a solid yield. Many checking accounts still show rates at basically zero, unfortunately.
The bottom line
Do not neglect stocks for the long haul. U.S. equities have historically rewarded long-term investors with returns near 7% per year after inflation. Short-term Treasury securities, by contrast, don’t usually earn you much more than the inflation rate over the long haul. If your time horizon is beyond several years, a stock-heavy portfolio should still win out.