After the Federal Reserve started raising interest rates in 2022, yields surged on low-risk CDs, short-term bonds, and money market mutual funds. Since then, many investors have been able to earn attractive yields on their money without the ups and downs that come with investing in stocks. Even after the Fed cut its key interest rate in 2024, longer-maturity CDs continued to pay the higher yields they had been issued with, and while money market fund yields dipped, they still remained higher than they had been in years.
Now, with the Fed expected to begin what may be a series of rate cuts, many of those high-yielding CDs are maturing—if they haven't already—and money market fund yields will likely follow interest rates lower. For investors, the question is what to do next.
Should they stay in short-term investments or could they better meet their investment needs with longer-maturity bonds?
While it is nearly impossible to pick the perfect moment to reinvest your cash proceeds into bonds, potential rate cuts by the Fed could mean that investors who stay in short-term investments may risk missing their opportunity.
What is risky about short-term investments?
While short-term investments are great for maintaining liquidity and flexibility and avoiding the risk of losing money in a market downturn, they are not risk-free. Having too much of them creates its own risks. Possibly the greatest of these risks is that a portfolio with too much in short-term positions won’t earn enough over the long term to stay ahead of inflation.
Historically, when the central bank has cut rates, yields on short-term investments have also come down. That means that those attractive interest rates on money market funds will also come down. It also means when the short-term CDs and bonds you now own mature, you may be unable to find new ones that pay as much as the old ones did. This is called reinvestment risk.
If not short-term investments, then what?
Fortunately, you do have an alternative to watching lower interest rates eventually reduce your portfolio’s ability to generate the income you need, and it does not have to involve investing in stocks. Longer-maturity investment-grade bonds issued by companies with high credit ratings and by governments have historically delivered higher returns than either short-term investments or stocks when the economy is contracting and interest rates are no longer rising. By investing in bonds with maturities of between 3 and 10 years, or in a bond mutual fund or ETF, with durations typically found in the Bloomberg US Aggregate Bond Index, you can avoid the risks posed by holding too much in short-term investments, and instead potentially continue to earn the level of return you seek from your portfolio.
What happens to bonds and cash when rates fall?
While the US economy continues to grow, some economic indicators may suggest the economy has slowed. When the economy slows, central banks typically cut interest rates in hopes of stimulating the economy, and yields on money market funds and other short-term cash destinations come down. While yields on newly issued bonds will eventually also come down along with rates, the interest, (or “coupon”) that a bond pays remains unchanged until the bond matures or is redeemed by its issuer. That makes it possible for investors in longer-maturity bonds to enjoy today’s relatively high yields well into the future, even after rates come down and short-maturity investment returns suffer.
Bond yields follow interest rates, and they also move in the opposite direction of bond prices. That means when bond rates and yields come down, as they are likely to if the Fed cuts short-term rates, bond prices are likely to rise. Because the total return that a bond delivers to its holder is a combination of the coupon yield and any changes in the bond’s price, the combination of potential rising prices in the future and relatively high yields in today’s market could deliver returns that are significantly greater than those available on short-term investments.
Keeping your balance
Another potential risk that comes from not reinvesting your maturing short-term investments into longer-term bonds stems from the fact that short-term positions have historically not provided as much protection as bonds from the declines in stock prices that often take place during economic slowdowns. In recessions, it is not unusual for stocks to decline by double-digit amounts. But when stocks have historically sunk, bond prices have often risen by double-digit amounts. While short-term positions did not lose value like stocks during those periods, they also did not gain in value like bonds, which means that the overall value of an investor’s portfolio was more likely to be pulled down by sagging stocks if they had too much in short-term positions and not enough in bonds.
Fidelity can help you find the right mix of cash and investments
Professional investment management services such as those offered by Fidelity's managed accounts do not allocate large amounts of money to short-term investments. Instead, they stay invested according to a long-term investing plan. Fidelity offers a wide variety of research tools to help you reduce the risks posed by staying too long in short-term positions.
We also can help you create a plan to manage risk in your portfolio and can even help manage that portfolio by looking at your timeline, goals, and feelings about risk to create a mix of investments that’s right for you.