After more than a decade of record low and near-zero interest rates, cash is king once again.
For the first time in years, cash investments are fetching sizable returns upward of 4% to 5%. Compare that to March 2022, when you were lucky to find rates of 1% or 2% on high-yield savings accounts.
Cash became more attractive when the Federal Reserve began raising the federal funds rate in March 2022 in an attempt to curb skyrocketing inflation.
When the federal funds rate increases, it affects the interest rates of banking products.
Federal Reserve Chairman Jerome Powell has indicated that interest rates will likely continue climbing. That’s bad news for consumers with credit card debt and those looking to buy a home, but higher rates are great news for savers.
“More people are looking at savings vehicles that have been safely ignored for over a decade,” said Jeremy Bohne, a financial advisor and founder of Paceline Wealth Management.
But simply keeping your cash in a traditional savings or checking account won’t do you much good. Interest rates at traditional banks remain low.
If you want your money to grow — and still remain fairly accessible — there are several options out there, including treasuries, certificates of deposit (CDs) and high-yield savings accounts.
5 Types of Cash Investments
Cash doesn’t have to mean cash. Money stashed under your mattress isn’t doing any better than it was 15 years ago.
By cash, we mean conservative investments and interest-earning bank products.
There’s a few different cash assets out there. Here’s how they work.
1. High-Yield Savings Accounts
A high-yield savings account is an interest-earning account mostly offered by online banks and credit unions.
High-yield savings accounts offer two major perks:
- They’re safe: Savings accounts are insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC). Even if the bank goes bust, your money is protected.
- They’re liquid: A liquid asset is easy to access. Savings accounts are very liquid because you can take money in and out without penalty (though some banks may restrict you to a certain number of withdrawals per month.)
They also offer substantially higher interest rates than a traditional savings account.
How much more?
The national average yield for savings accounts was 0.37% on March 20, 2023, according to the FDIC. Compare that with some of the best high-interest savings accounts, which offered an APY of 4% or more during the same time.
If you deposited $5,000 into an account earning 0.37%, you’d earn just $18.50 in a year. But if you deposited $5,000 into a high-yield savings account earning 4.3%, you’d make $215 in a year — potentially more if interest rates keep rising.
Not too shabby!
“Consumers who are holding too much cash in checking or regular savings accounts can potentially earn a lot more by exploring options like high-yield savings accounts,” said David Edmisten, a certified financial planner and founder of Next Phase Financial Planning.
You likely won’t find high-yield savings accounts with attractive rates at brick-and-mortar banks. Online banks like Ally and SoFi can afford to give customers higher rates because they don’t face the same overhead costs as traditional banks.
2. Certificates of Deposit
Investing in a CD, or a certificate of deposit, is a good way to earn more interest than you’d get with a regular savings account.
Online CDs tend to earn comparable rates to high-yield savings accounts, though you may find slightly better CD rates for longer terms, depending on the financial institution.
You’re required to lock up your money for a certain time — anywhere from three months to five years or more — and in return, you receive a fixed interest rate on your deposit. Typically, the longer the duration, the higher the interest rate. CDs are also FDIC insured, just like checking and savings accounts.
Here are the downsides: You risk losing your interest and even some principal if you need to withdraw money before the CD’s maturity date.
As interest rates rise, another risk with CDs is tying yourself to a certain APY, only for rates to jump again in the future.
Buying a two-year online CD with a 1.5% APY may have felt like a great rate in April 2022, when the Fed had just started hiking the federal funds rate.
Flashforward to April 2023 when one-year online CDs are offering APYs of 4.5% to 5%, and suddenly being locked up in a modest 1.5% APY for another eight months doesn’t feel like such a great rate anymore.
One way to offset some of this risk is practicing bond laddering.
Building a bond ladder involves purchasing bonds of varying maturities, holding them until they mature, then reinvesting them.
This staggered approach gives you some flexibility in responding to a shifting interest rate environment.
3. Money Market Accounts
You can also see if your online bank or credit union offers a money market account. These accounts share many similarities with high-yield savings accounts. For the average consumer, they’re pretty interchangeable.
The only major differences? Money market accounts come with a debit card and check-writing privileges, and usually require a higher minimum deposit than a savings account.
If you’re considering a money market account, it’s worth comparing what you can earn from high-yield savings accounts. The minimum deposit and minimum balance requirements may be lower with similar rates.
4. Money Market Funds
Not to be confused with a money market account, money market funds are actually mutual funds that invest in low-risk, short-term debts, such as CDs and U.S. Treasuries.
They’re typically sold by brokerage firms and mutual fund companies.
The returns are often on par with CD interest rates. One advantage: It’s a liquid investment, which means you can cash out at any time.
But because they aren’t FDIC insured, they can technically lose principal, though they’re considered very safe.
When you buy treasuries, you’re investing in securities backed by the full faith and credit of the U.S. government. Unless the federal government defaults on its debt for the first time in history, investors get paid.
There are a few types of Treasuries with various maturity dates:
T-bills are standing out from the pack of other treasuries right now. They have the shortest-term yields, so the bond matures in less than a year, with terms as short as a few days.
T-bill yields are higher than they’ve been in over a decade. In March 2023, the yield on a 52-week T-bill was near 5%, which is shockingly high for these investments.
You can buy T-bills and other treasuries straight from the U.S. government through the TreasuryDirect website.
But some experts and investors prefer to purchase treasury ETFs — short for exchange traded funds — which are bought and sold on market exchanges.
“I like buying treasuries inside of a short-term treasury ETF instead because it’s more diversified across time periods and interest rates,” said Erik Baskin, a financial planner and founder of Baskin Financial Planning.
Cash Is King — But Not For Everyone
Cash-related investments are having a moment right now — but nothing lasts forever.
Historically, the stock market has outperformed other investment types long-term. Stocks might be struggling today, and may be volatile over the next year or two.
However, stocks have a remarkable track record of outperforming the total return of cash-related investments over time.
In other words, relying too heavily on cash can make it harder to reach your long-term financial goals.
“These cash vehicles should be reserved for short-term savings goals, such as a car or a house down payment,” Baskin said. “Cash-like vehicles are paying great rates right now, but these rates can and will likely decrease in the coming years.”
If you’re a younger investor with decades before retirement, financial experts agree it’s better to stay invested and wait for the market to rebound.
Experts also don’t recommend investors “cash out” of the stock market and alter their approach just because cash rates are higher.
“When you sell a stock, you’re crystallizing those losses or gains,” Bohne said. “From an investment standpoint, dumping stocks and taking a loss just to earn interest on cash doesn’t work out well.”
When Is Cash Beneficial?
On the flip side, for risk-averse investors as well as people approaching or already in retirement, a larger cash allocation can make sense.
“For retirees living off of their investment portfolios, consideration should be given to how to shift from more risky asset classes into less risky asset classes, like cash, to cover expenses,” said Tim Melia, a certified financial planner at Embolden Financial Planning.
Some experts recommend people within a couple years of retirement or already in retirement keep enough cash to cover 18 to 24 months of expenses.
“This can reduce the need for retirees to liquidate their investments when markets are down,” Edmisten said.
Cash is king when it comes to your emergency fund as well, which experts say should equal at least three to six months’ worth of living expenses.
Sitting on more cash also makes sense if you have a big purchase coming up in the next one to three years. Think buying a house, purchasing a car or paying for a wedding.
Pros and Cons of Cash-Related Investments
So when does cash make sense? And when are you better off investing your money elsewhere?
Keep these things in mind as you explore cash-related investments.
- Low risk
- Interest rates keep going up
- Cushion in recession
- Inflation devalues cash
- Timing the market is hard
- Miss other investments
- May pay taxes sooner
Cash-related investments are generally liquid, meaning you can easily access your money when you need it.
Savings accounts and money market accounts, in particular, let you withdraw funds without penalty.
This means cash is king for investors who need quick access to their money in case of an emergency.
Pro: Low Risk
Cash investments are considered safer than other investments because they are backed by government guarantees or are insured by the FDIC.
Many cash investments also offer predictable returns, in contrast to the volatile nature of stocks.
Pro: Interest Rates Keep Going Up
Rising interest rates are good news for savers. It means the APY on your high-yield savings account will likely enjoy regular rate bumps for the near future.
Pro: Provides a Cushion in Case of Recession
A cash reserve gives you the flexibility to weather any financial storms that might be on the horizon.
If a recession hits, stock prices will likely plunge for a spell. So if you fall on hard times and need to tap your brokerage account or IRA during a stock market crash, you’ll likely have to sell shares at a loss. No one wants that.
The job market also usually takes a hit during a financial crisis. If you’re laid off from work, cash reserves can be a lifesaver, helping you avoid piling on tons of credit card debt or taking on high-interest loans.
Con: Inflation Eats Away at Cash
There’s some irony here: Cash is more attractive because interest rates are rising. Interest rates are rising because inflation is high. And high inflation erodes the value of cash over time.
So, while that 4% return on your high-yield savings account is alluring, it isn’t keeping pace with inflation, which remained at 6.04% in March 2023. Your spending power is still decreasing over time.
“It’s a good reminder to be very thoughtful about how much cash you hold,” Melia said.
Con: Timing the Market Is Really Hard
Buying the dip — which refers to buying stocks when prices are low — sounds great. But in reality, it’s impossible to predict exactly when the market will crash and rebound.
“The risk of buying the dip is that it may never come, or it may not be identified at the right time,” Melia said.
You could end up investing your cash in stocks too early, too late or not at all, leaving you with a portfolio full of cash and lackluster long-term gains.
Con: You Could Miss Out on Other Opportunities
When you invest in cash-related investments, you’re missing out on the potential returns offered by other assets, such as stocks and bonds.
Buying certain cash investments can also mean locking in a lower interest rate (think CDs like we mentioned earlier).
Con: You May Need to Pay Taxes Sooner
You have to pay taxes on savings account and CD interest each tax year — even if you leave the cash in your account.
Compare that with a brokerage account, where taxes are only due when you sell stocks at a profit and realize a capital gain. For traditional 401(k)s and IRAs, taxes are deferred until you withdraw money from the account, which can punt your tax bill down the road for years.
The Bottom Line
Cash is looking better than it has in years.
Experts generally recommend keeping a cash emergency fund and allocating about 5% of your investment portfolio to cash.
But depending on your age, risk tolerance and financial goals, a bigger cash allocation can make sense.
With high short-term interest rates and a recession potentially on the horizon, cash is likely to reign king in 2023 — and possibly beyond.
Rachel Christian is a Certified Educator in Personal Finance and a senior writer at Codetic. She focuses on investing, retirement, taxes and life insurance.