Cash investment strategy remains favored after the Fed rate cut, but reinvestment risks are emerging
After the Fed rate cut, cash investment strategies remain popular, with money market fund assets exceeding $6.3 trillion. However, Wells Fargo analysis points out that investors face reinvestment risks and may find it difficult to find a 5% return opportunity without increasing risk. It is recommended that investors reduce cash holdings and shift towards medium-term fixed income investments, such as residential mortgage-backed securities and municipal bonds, to lock in coupon income and potentially benefit from asset price appreciation. Research shows that the returns on high-risk assets far exceed cash alternatives
Even as the Federal Reserve begins to cut interest rates, the strategy of earning a 5% return in "cash" investments without taking on too much risk remains popular among investors. According to the Intelligence Finance app, last week, the total assets of money market funds - a popular cash investment tool since 2022 - exceeded $6.3 trillion, even after the Fed announced a significant 50 basis point rate cut.
However, according to analysis from Wells Fargo Investment Research Institute, this strategy also brings "reinvestment risk." With the bond market readjusting to lower rates, investors will find it difficult to find opportunities that do not increase risk but still provide a 5% return.
Wells Fargo's global investment strategist Michelle Wan believes that now may be the time for investors to reduce their allocation to cash alternatives and shift towards "mid-term" fixed income investments, such as residential mortgage-backed securities and U.S. municipal bonds.
In a client report on Monday, Wan wrote that this strategy can "help investors lock in coupon income and potentially benefit from asset price appreciation during periods of declining market rates."
Furthermore, Wan pointed out another risk, "cash drag." She and her team studied the performance of investing $1 million in higher-risk assets since 1926 and compared it to cash and cash alternatives. The research found that small-cap stocks performed the best, with a $1 million investment growing to $620 billion; large-cap stocks grew to $210 billion, while U.S. Treasury bills as cash alternatives grew to $24 million.
According to FactSet data, on Monday, the stock market continued to hit record highs, with the Dow Jones Industrial Average rising by 0.15%, the S&P 500 Index rising by 0.28%, and the Nasdaq Composite Index rising by 0.14%