Sure, Cash Is Cool Again, but Bonds Are Better

Lawrence Gillum | Chief Fixed Income Strategist

Last Updated: May 23, 2024

After ten years of nearly zero cash yields, the Federal Reserve's (Fed) sharp increase in rates has raised cash rates, leading investors to place almost $6 trillion in cash accounts. And while cash yields are attractive, another attractive attribute for cash is the low risks associated with it. Cash has done a great job in recent years helping investors protect their portfolios from market turbulence. That was especially true in 2022, when both stocks and bonds experienced large drawdowns. But, with Fed interest rate hikes likely behind us, cash as an asset class may not be as important to portfolios as it was recently.

And we know those attractive cash rates aren’t going to last forever. Just as the aggressive rate hiking cycle took Treasury yields higher, interest rate cuts will eventually take all cash rates lower as well. However, with bond yields still elevated and likely to stay around current levels, investors can extend the maturity of their excess cash holdings by locking in current bond yields (not too far out on the curve, though). Locking into high-quality, intermediate-term fixed income can provide consistent cash flow and desirable income levels for years to come, regardless of what lies around the corner.

Moreover, bonds offer an optionality that you don’t get from cash. Although bonds and cash currently offer similar yields, bonds provide extra portfolio protection and the chance for price increases if the economy faces unexpected challenges, which cash does not offer. Additionally, over the past 40 years (ending April 2024), bonds have averaged a 6.1% annual return versus about 3.5% for cash. And bonds have been consistent outperformers. From January 1986 to April 2024, bonds had a better five-year return in 95% of the rolling five-year periods. In those few instances where cash did better, it only outperformed by less than 0.5%, on average. So, with cash rates likely to fall as the Fed cuts rates, bonds have demonstrated they do a better job than cash at helping investors grow their assets over the long term.

Bonds Tend to Outperform Cash Over Time

Trailing 5-year Annualized Total Returns

Source: LPL Research, Bloomberg 05/22/24
Disclosures: All indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results.

Investing is largely about setting up portfolios for future success. We definitely consider cash as a valid asset class now, especially for investors with short-term goals spanning a few quarters to a couple of years. However, unless investors have short-term income needs, they may be better served by reducing some of their excess cash holdings and extending the maturity profile of their fixed income portfolio to lock in these higher yields for years to come. Bond funds and ETFs that track the Bloomberg Aggregate Index, along with separately managed accounts and laddered portfolios, all represent attractive options that will allow investors to take advantage of these higher rates before they disappear.

Important Disclosures

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk.

Indexes are unmanaged and cannot be invested into directly. Index performance is not indicative of the performance of any investment and does not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

This material was prepared by LPL Financial, LLC. All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.

Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

Asset Class Disclosures –

International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.

Bonds are subject to market and interest rate risk if sold prior to maturity.

Municipal bonds are subject and market and interest rate risk and potentially capital gains tax if sold prior to maturity. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply.

Preferred stock dividends are paid at the discretion of the issuing company. Preferred stocks are subject to interest rate and credit risk. They may be subject to a call features.

Alternative investments may not be suitable for all investors and involve special risks such as leveraging the investment, potential adverse market forces, regulatory changes and potentially illiquidity. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses.

Mortgage backed securities are subject to credit, default, prepayment, extension, market and interest rate risk.

High yield/junk bonds (grade BB or below) are below investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.

Precious metal investing involves greater fluctuation and potential for losses.

The fast price swings of commodities will result in significant volatility in an investor's holdings.

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Lawrence Gillum

Lawrence Gillum, CFA, guides the fixed income view for LPL Financial Research and has over 20 years of investing experience.