Is cash king? Many investors seem to think so.
They’re streaming into money-market funds, lured by elevated yields and a desire to avoid the wild swings in equities.
But for fixed-income investors, the impulse to park cash is a trap.
The Federal Reserve Board is attempting to tame inflation by raising interest rates and slowing the economy. As its mission grinds on, muni investors who choose to sideline their funds instead of taking advantage of attractive yields will look back later with regret.
Staggering pile of parked cash
Investors began flocking to money market funds during the volatility in equities in 2018.
Then, amid the onset of Covid-19 and rampant economic fears in the spring of 2020, money-market funds grew by more than $1 trillion and stayed there over the next two years, even as their yields scraped 0%.
More recently, the wave of deposits turned into a typhoon. Since last April, investors added more than $350 billion to money markets. By February, money market assets reached $4.82 trillion, according to Lord Abbett, exceeding pandemic-era levels.
The total cash and short-term equivalents investors have sidelined has reached more than $19 trillion.
Parking funds for munis leaves money on the table
Money markets make sense for short-term cash management. But investors parking cash for the longer term can leave a lot of income on the table.
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As we’ve noted (“Don’t Be Fooled by the Fed”), higher short-term rates driven by the Fed ultimately lead to lower long-term rates as the economy cools, and long-term rates are the province of municipal bond investors.
Now we’re seeing the economy slowing; how much and how fast is anyone’s guess. But there are still juicy yields available on municipal bonds.
For example, the tax-equivalent yield on 30-year, A-rated municipal bonds reached more than 7.00% recently for those at the 40.8% tax rate.
Municipal issuers are generally healthy and building rainy-day funds. Defaults, which have always been rare, fell even further in the first quarter of this year, a remarkable feat as signs of a weakening economy emerge.
Parking investment funds hoping muni yields will rise even higher has never made sense. It assumes an investor’s ability to predict the future, which no one has successfully done for any length of time.
Invariably, the attractive money-fund yields available now will ease, as will investor enthusiasm.
Municipal bonds, on the other hand, generate a steady stream of tax-free income at a stated maturity date and stated yield. Their reliable if unexciting nature is the source of their enduring appeal.
Parked money is lazy money and prevents investors from enjoying these benefits.