Investors may want to rethink their cash allocations heading into 2025, many on Wall Street are warning. Yields on cash-equivalent investments like money market funds , certificates of deposit and Treasury bills follow the Federal Reserve ‘s interest-rate moves. The central bank meets next week and is widely expected to slash rates by another quarter percentage point, bringing the federal funds rate to between 4.25% and 4.5%. Lower yields notwithstanding, Americans’ love affair with cash doesn’t appear to be fading anytime soon. A record $6.77 trillion is sitting in money market funds, as of the week ended Dec. 4, according to the Investment Company Institute . That’s almost half a trillion dollars more than was held in money markets in September, before the Fed made its first rate cut in four years, followed by another in November. While money market funds have seen their yields decline, they should continue to take assets from lower-yielding bank deposits, said Peter Crane, founder of Crane Data, a firm that tracks money markets. His Crane 100 Money Fund Index , which is based on the largest taxable money funds, had an annualized seven-day yield that topped 5% earlier this year. It has since fallen to 4.43%, as of Wednesday. Crane expects yields to remain above 4% heading into next year and above 3.5% in 2025. “Money funds continue to benefit from their greatest attribute — market rates of return — as short-term interest rates remain attractive in both nominal and real terms,” he said. What the Fed will do next year with rates is unclear. Inflation is far below its 2022 high, but has started ticking up again the past couple of months. The consumer price index accelerated to a 12-month rate of 2.7% in November, according to the Bureau of Labor Statistics, still above the central bank’s 2% target. In addition, wages continue to remain strong and there is concern that President-elect Donald Trump ‘s policies may push prices higher. Vanguard expects inflation to remain above 2% throughout 2025 due to “sticky” housing and services inflation. The money manager, which runs more than $9 trillion in assets, projects the fed funds rate will decrease to 4% by the end of next year. But if inflation rebounds, the central bank would have to slow its pace of easing or even possibly reverse course and raise rates, the firm said in its 2025 outlook. “The era of sound money — characterized by positive real interest rates — will endure, setting the foundation for solid cash and fixed income returns over the next decade,” the Vanguard team wrote. Cash has lagged other assets With yields the highest in years and uncertainty about inflation and the economy, it’s no surprise people have parked spare cash in money markets, certificates of deposits, high-yield savings accounts and Treasury bills. A July survey by Empower found 49% of Americans felt safer holding cash versus other investments. The financial services company polled 1,009 U.S. adults. Cash makes up more than 27% of its users’ portfolios, Empower said. However, the general rule of thumb is to keep just 3% to 5% of your portfolio in cash for emergencies and other liquid needs, said Luis Alvarado, global fixed income strategist at Wells Fargo Investment Institute. “If we look at historical evidence, cash as an asset class has lagged very significantly over a long period of time,” he said. In fact, the S & P 500 had a total cumulative return of 35.5% from July 30, 2023 to December 11, he noted. Money market funds, with 12-months yields about 5%, averaged around a 7.34% return during that same time period, Alvarado said. He used the Morningstar U.S. Fund Money Market-Taxable category as a proxy. UBS is also warning of cash’s poor performance. “Recent years have been dismal for real returns on cash, with higher interest rates not sufficient to offset the surge in inflation,” Mark Haefele, chief investment officer at UBS Global Wealth Management, said in the bank’s 2025 outlook . Since the start of the decade, the real purchasing power of cash has fallen by 8% in U.S. dollars, he said. “We expect cash to remain among the worst-performing major asset classes,” Haefele added. “A rate-cutting cycle is underway, eroding future returns on cash. Meanwhile, secular trends such as deglobalization, decarbonization, higher debt, and an aging population may put periodic upward pressure on inflation, eroding cash’s after-inflation returns.” Like timing the market John Queen, fixed income portfolio manager at Capital Group, likened cash to the legal concept of “attractive nuisance.” “It is something that pulls people in but is actually dangerous,” he said. By the time people realize their cash yields have fallen, bonds have already rallied and they missed out on locking in attractive yields, he explained. “Owning cash makes you a market timer and nobody is a good market timer,” he said. “Cash is a trap for most people.” Locking in income Investors’ portfolios should be tailored to their time horizon and risk profile, Queen said. Core bonds are an important part of that fixed income position, he said. The money manager also sees opportunity in structured credit as well as parts of the commercial mortgage-backed and auto asset-backed securities markets. Wells Fargo Investment Group favors extending maturities through a bond ladder strategy — first in intermediate duration (3 to 7 years), next in longer-dated maturities and then in shorter maturities, the firm said in its 2025 investment outlook. “Investors could consider this sequence when purchasing new fixed-income securities, redeploying maturing securities or reallocating among selected managers to achieve this laddering,” the team wrote. Income investors can also turn to dividend-paying equities. “U.S. large-cap companies have accumulated over $2.4 trillion in cash on their balance sheets and could choose to initiate or increase dividend payouts,” Wells Fargo said. UBS is also advising investors to shift excess cash into assets that provide higher and more durable sources of income. It said the risk-reward profile of investment-grade (IG) corporate bonds is favorable, even though the assets are expensive relative to Treasurys. “In a portfolio context, we think that complementing IG bonds with riskier credit (like U.S., EUR, and Asia high yield, emerging market bonds, or senior loans) can improve diversification and increase returns,” Haefele said. “For investors managing single bond portfolios, we recommend a focus primarily on quality bonds but augmenting those with select investments in short- and medium-duration riskier credits,” he added.
