As major stock market indexes give up their gains for the year in this week’s sharp selloff, cash may be looking like a decent alternative. Goldman Sachs strategists highlighted cash as a competitive option to stocks for the first time in years as they offered clients their market outlook for 2019. It is a good time to brush off that cash strategy, especially if you are retired.
Goldman strategists said in a note this week that they expect cash to return about 3% total by the end of 2019 as the Fed raises interest rates to 3.25% to 3.5%. That is certainly a lot more than cash has returned for many years, and it’s even more attractive relative to their expectations for U.S. stocks. After accounting for expected volatility, Goldman expects the S&P 500 (.SPX) to generate an expected risk-adjusted return of just 0.5%, next year.
One more plug for cash: The bull market has left households, pensions, mutual funds and other investors with cash allocations of just 12%, the lowest in 30 years. Meanwhile, allocations to stock sit near 44%, a level surpassed only during the technology bubble, according to Goldman.
Given the age of the bull market and rising interest rates, some financial advisers have recommended that retirees who are already 70.5 years old and withdrawing required minimum distributions to build a cash bucket within a 401(k) or IRA so that they are not forced to pull RMDs from parts of the portfolio that may be declining.
The next step is sorting out where to put that cash. Anything meant to fund an RMD or another immediate expense should not be parked in funds that take credit risk, including ultrashort bond funds that have been popular as investors looked for a place to hide from rising rates. As a rule of thumb, anything that pays more than inflation is probably taking on more risk than is suitable for such cash, says Manisha Thakor, vice president of financial education at independent investment adviser Brighton Jones.
Within 401(k) plans, there are fewer options for cash since the Securities and Exchange Commissions implemented new rules last year, with stable value funds and government-focused money-market funds as the most common choices. Government-oriented money-market funds aren’t FDIC-insured like money-market accounts, but are among the safest options, according to Morningstar’s Christine Benz. One thing to watch for: Fees. While 401(k) mutual-fund investors tend to pay lower-than-average expense ratios on most funds, money-market funds in 401(k) plans had slightly higher average fees, an average expense ratio of 0.28%, than funds outside plans, with an average expense ratio of 0.25%, according to Investment Company Institute data. A quick scan of Morningstar’s money-market category even showed several funds charging more than 1%.
The other cash option in 401(k) plans comes in the form of stable value funds. These funds typically yield somewhere between short-term and intermediate-term bonds, but may be slower to react to rate increases than money-market funds. Stable value funds invest in bonds, but come with an insurance wrapper that helps maintain net asset value. These funds are only available inside 401(k) plans and investors are typically stuck with whatever option is in the plan. One way to evaluate costs is to look at net yields. If neither option in a 401(k) plan is all that attractive, retirees can roll over money into an IRA and fund RMDs using laddered CDs or short-term Treasury bonds.
For those not in RMD-mode, it still makes sense to have a cash reserve, especially given where valuations are. Thakor recommends enough to cover about three years of expenses, which should enable someone to outlast a bear market without having to pull from depressed accounts. But for those not yet forced to withdraw from their tax-deferred assets, the majority of that cash reserve–especially anything meant for dry powder for investing during a market downturn–should not be held in tax-deferred accounts, since even someone 59-and-half years old has more than a decade left to let the portfolio recover from any downturns and benefit from its tax-deferred status. Better places to park the cash: money-market funds or online savings accounts.
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