Ever since 2020, short-term rates have been rather favorable for investors in comparison to history (remember when money market funds paid over 5% – the good old days!) As the effects on the pandemic have subsided on many fronts, the fed funds rate has steadily declined and has taken the market rates on cash savings down with it.

This downward move in rates has led to discussions with clients in recent weeks concerning what should be done with cash balances now – before rates fall any further (fortunately for savers, the fed held rates constant today so you still have some time).

In deciding what to do with your cash balances, it’s important to understand the role(s) the cash plays in your financial life and/or your investment portfolio.

Cash can serve multiple purposes. Below is a list of four such categories and how to consider investing each in this moment before rates decline further

1. Emergency Funds – this is cash you keep on hand “just in case.” I’ve written about the various items to consider when setting your level of emergency funds. These funds (by their definition) are for unplanned and unknown events (ie: emergencies). As a result, the most important item of consideration for this cash is its liquidity/availability – not its earnings. Given that, emergency funds are best held in a bank account (ie: savings account, money market account) or a money market mutual fund at a broker/dealer. Both are very liquid and will pay market rates of interest
2. Specified/Earmarked Savings – Cash can also be set aside to pre-fund known items. These could range from home improvement projects, a down payment on a new home, a vacation fund, the cash you need to fund an IRA or HSA for the year, and countless other items you want to save for before they arrive. While a bank account or a money market fund can work for these expenses too, since this cash is held for a known date/timeframe, you can consider locking in rates before they fall. For example, if you have cash saved for a remodel you are starting in 9 months, you could buy a 9-month CD or a treasury bill now. These securities will guarantee that rate of interest over the term, regardless of if the fed cuts rates between now and then. Before moving forward, verify that you are confident in the term though – for CDs, you will pay a penalty for early redemption and for t bills, if you redeem early, you may lose some principal value depending on rate moves
3. Future liquidity – If you are living off your portfolio, you may withdraw a certain amount of funds from your accounts on a set frequency (monthly, quarterly, annually, etc). If the frequency is known, see options in #2 (CDs or t-bills). If you are unsure of when you will need the cash, stick with a bank account or money market fund solution
4. Asset Allocation – In a diversified portfolio, an allocation to cash is usually appropriate. Some investors choose to barbell (hold a meaningful amount of cash to offset volatility in risk assets). Others keep cash on hand to add to other asset classes in the event of market weakness (referred to as “dry powder”) If you hold a meaningful cash weight that you won’t necessarily spend or deploy, you could consider using a bond ladder. This allows you to lock in rates for certain intervals (ie: rungs in the ladder) and then decide to spend it and/or reinvest it. (I described laddering in more detail here). If you hold cash for trading purposes (ie: to add to your equity holdings at lower levels), keeping it in cash or a money market fund (tradable in one day) would be reasonable

Hopefully this helps give you some framework to apply to your cash holdings. As always, work closely with your advisor and consider your own circumstances before taking any actions.