The upside of rising interest rates? You can earn higher returns on savings and other cash holdings — if you know where to look.

SMI's executive editor Mark Biller discussed that topic a few days ago on MoneyWise. Mark and host Rob West also answered questions from callers. 

The audio is posted below. Scroll down for a transcript.

MoneyWise airs weekday mornings on American Family Radio. A different version airs weekday afternoons on Moody Radio.

For more radio appearances by members of the SMI team, visit our Resources page.


Transcript

Rob West:
This year saw the stock market go from a rocket launch to a rollercoaster ride, and many investors have decided to climb off. Hi, I'm Rob West. Today I'll talk with Mark Biller about an option you may want to consider: money-market funds.

Then it's on your calls at 800-525-7000. That's 800-525-7000. Call right now. This is MoneyWise on American Family Radio — biblical wisdom for your financial decisions. (theme music ends)

Well, Mark Biller joins us again today. He's executive editor at Sound Mind Investing, an underwriter of this program. And Mark, welcome back to the program.

Mark Biller:
Thanks, Rob. Good to be back with you.

Rob West:
Well, it's great to have you here. So money-market funds, they haven't been too popular in recent years, Mark, as interest rates have been hovering around that zero mark. But you have an article in your latest SMI newsletter about how that perhaps is changing. So why don't you start there and fill us in.

Mark Biller:
Yeah, sure. So you're exactly right that things have been changing and money-market funds have been gaining in popularity. First of all Rob, there are a few common reasons why someone might find themselves with a chunk of cash that they're looking for a home for. One example of that, that's very common. is when a person either completes or is building their three- to six-month emergency savings goal. And they're looking for the best place to store that emergency cash.

Another one that we run into a lot at SMI is when an investor either takes money out of the market temporarily, or they've got money ready to invest that they haven't put to work yet, and they're looking for "Where can I store this cash until I put it to work?"

And whatever the reason for having that cash is one old option that has been largely abandoned — as you kind of alluded to— until recently, is now back in play. And that's the money-market fund. And the reason for that is very directly, these higher interest rates and higher yields that are being offered have kind of brought them back in the game.

So what is a money-market fund? It's just a specific type of mutual fund that invests in very short-term, very safe debt — often issued by the government or, in some cases, it can be issued by large banks or corporations, depending on what type of money-market fund you're using. And in either case, whatever the type, because the debt that we're talking about is so short term and is issued by these very solid sources, the risk that you're taking in a money-market fund is usually extremely low. And the advantage that you get in a money-market fund is rates tend to be higher than what most banks are typically paying on their savings accounts.

So it's important to recognize these aren't new. They've been around for half a century or so, and for most of that time they've been a great, very widely accepted option for safe cash holdings.

Rob West:
Yeah. You mentioned "most of that time." A lot of that changed in 2008, didn't it?

Mark Biller:
Yeah, it really did. And the main reason was that after the global financial crisis in 2008, the Federal Reserve lowered short-term interest rates to almost zero and then left them there for about a decade. And when there's no yield to be found anywhere, the extra step of using a money-market fund really doesn't make any sense. So people naturally quit doing it. But now that short-term interest rates are climbing back up near 4%, money-market funds are back in the game, investors are paying attention, and over the last several months, total assets invested in money-market funds has really surged.

Rob West:
Now Mark, let's be clear, we're talking about this as a replacement perhaps for a high-yield savings account. Not a good way to grow, though, your capital — correct?

Mark Biller:
Yeah, that's exactly right. Money-market funds are great for one specific job and that is storing your liquid cash. They are not a good choice for growing your capital over the long term. So exactly what you said, Rob: great alternative for savings accounts, but these are not something that you want to use within your investment accounts, except as a short-term cash holding.

Now, if that's what you need within your investment account at a particular moment in time, they're a great choice. But it's not gonna be something that you wanna sock away in your IRA and leave it there for 10 years because it's not gonna grow your capital the way you need it to.

Rob West:
All right, Mark. Thanks for that helpful distinction. Now, money-market funds aren't the only option though for parking short-term money. So perhaps you could help us understand why someone might want to use, say, an online savings account versus a money-market fund versus even a bond fund.

Mark Biller:
Yeah, absolutely. It's a great question. And a lot of it is gonna come down to what a person has convenient access to, along with what the purpose of that money is like we've been talking about. But let's unpack those three options just a little bit. So if you have money in your checking account and you go to move it to your bank savings account, chances are your local bank is still paying almost nothing on those bank savings. They just are not incentivized to pay that. And so they aren't.

And so that's where we need to start looking out further afield than your local bank. And the first place most people will look is an online savings account. They can be a great super easy way for people to move excess cash to somewhere where it's gonna earn a little bit of interest.

So, for example, you have your direct deposit into your checking account. You set up an online savings account with a Capital One [bank] or any of these many options online, and with a few clicks of your mouse, you can move money from your checking account at your local bank to an online savings account. So just for kicks this morning I went out real quickly and just looked at a couple of rates from very popular online savings accounts. I'm not trying to pitch any particular one, so I won't tell you which one I'm looking at, but it's one that advertises a ton on TV, everyone would recognize it. And they're paying 3% interest on their online savings account right now. That's pretty good, especially if your local bank is not paying anything.

But if we move out now and talk about money-market funds, I did the same thing with one of the big national brokers. Again, everyone would recognize it — they advertise a ton on TV. And their money-market funds today are — their better ones — are yielding 3.7 to 3.8%. So that's a little better than the 3% you could get in the online savings account.

So that is, that kind of illustrates why people tend to look at a money-market fund as maybe a slightly better option for that cash. There's also one other thing that they do that most online savings accounts can't do for you, and that is that if you're in an investment account — in your IRA or that type of investment account — then if you have a need for cash over the short term, you can buy a money-market fund just like you'd buy any other mutual fund. That is a big help because you normally can't transfer that to an online savings account from within your investment account, if that makes sense.

So that can be a big help if you're temporarily in cash within your investment account, knowing that you can just park that money in a money-market fund is a big advantage.

Now when we talk about bond funds, Rob, they're a little bit different story. So bank savings accounts, online savings accounts, money-market funds are pretty similar in terms of the level of risk that's being taken. When we take that additional step out into the bond fund world, we need to understand that bond funds include a very broad range of investments that can range from the super safe stuff like we're talking about, but it can also range all the way out to super risky and still be a bond fund.

So when you're buying a bond fund, it's critical to understand exactly what you're getting because all bond funds are not created equal. And that's not a bad thing. That gives you a lot of variety, a lot of different uses for bond funds. But you need to nail down exactly what you're buying and does that match the specific purpose that you need. And that's the kind of thing that we talk a lot about within our Sound Mind Investing newsletter.

Rob West:
That's really helpful. I've got several more questions on these, but let's head to the phones. Carol's been waiting patiently in Oklahoma. Carol, you're on with Mark Biller. Go ahead.

Caller:
Hi! Good morning!

Rob West:
Hi!

Caller:
I just wanted to ask a few questions for clarification. So my husband and I are both 55 years old — kind of getting into seeing the light at the end of the tunnel for retirement. I've been pretty conservative with my investments in our 401(k.) He has been kind of a mix. But I heard you talking about the money-market mutual fund being something that could turn around some good increase for your investments. But in mostly — I thought I heard you say that it needed to be more of a cash, you know, investment. But should we, or could we, shift some of our investments in our 401(k)s at least for a little while into these mutual funds and do well, and then when the market changes for, you know, the interest rates, change it back or something?

Mark Biller:
Yeah, absolutely, Carol. And, in fact, our Sound Mind Investing investors are doing exactly that. They've got a portion of their investments in money-market funds right now because we are still waiting for what we expect will be a better buying opportunity for some of our money later in this bear market. The thing you want to keep an eye on and be careful with is that even though 3 to 4% interest sounds good right now, inflation is still running even higher than that. So you're actually just barely keeping up with or losing a little bit of ground by treading water in a money-market fund. So you don't wanna leave it there long term because you're not advancing your purchasing power. But it can be a great short-term option.

Rob West:
I think the key though, Mark, is not to take money that has ridden the market down and pull it out [to invest in a] money market [fund]. You want to give it a chance to recover, right?

Mark Biller:
Yeah, that's true. For the long term for sure.

Rob West:
Very good. Carol, thanks for your call today. We appreciate it. We're gonna take a quick break more with Mark Biller just around the corner. This is MoneyWise on American Family Radio. Stick around.


Rob West:
We were talking to our previous caller about perhaps shifting some of their existing portfolio into money markets. But right there at the tail end, we were saying perhaps not those investments that have declined that based on your investing strategy should be in equities. It's not a place just to wait out a recovery because you may miss the recovery, right?

Mark Biller:
Yeah. You do have to be really careful with that because the risk as you're saying is that you've ridden it down, now you're gonna move it over to cash and you miss a rebound. So a lot of this is going to depend on what your-long term investing strategy is. We always suggest that you have a long-term plan. And so if part of your plan includes having a cash allocation at this point, then this would be an appropriate thing. But you do wanna be really careful about selling and then missing a rebound.

So yeah, that is a little bit of a tricky thing, Rob. And of course, that depends on the outlook and the strategy that you're following, but hopefully, the point is very clear that you do not want to have your long-term investing money in cash in a money-market fund over the long term. This is a — if you have any of it in cash at this point — that's a short-term tactical decision, not a long-term investing position.

And you know, we've been focusing a lot on the investment account side of this, which is appropriate right now because we are in a bear market. It does have some uses there. But I definitely also want people to understand that money-market funds are a great savings tool. And so for the emergency fund, which most everybody should have as part of their financial foundation, money-market funds and these online savings accounts can be a great way to go from earning essentially no interest at your local bank to an interest rate that at least is gonna give you a fighting chance to keep up with inflation by getting up into that 3% to 4% kind of interest rate range right now. And of course, those rates will just keep going up if the Fed keeps pushing interest rates higher.

Rob West:
If you'd like to read this article, it's called Money-Market Funds Resume Role as Solid Option for Short-Term Cash. You'll find it at soundmindinvesting.org.

All right, back to the phones. James in Arkansas. Your next up sir. Go ahead.

Caller:
Yeah, hi there. Thank you for taking my call. I got two quick questions. I'm the caretaker of some of my parents' money. I got about $2 million that it's just, uh — they just wanted to see what other ways to try to invest it. They made most of their money in the '80s, so now it's just sitting there and I'm just trying to get ways or ideas to multiply it down the road. Back in the '80s, when you had 8%, 9% interest, you could double your money in like less than 10 years. Now it's like you need 50 years <laugh> or something like that. But I wanted to get your input about that.

Rob West:
Yeah. James, couple of questions. Are they living off of this $2 million or is this just continuing to grow?

Caller:
No, this is a separate amount. They're living off of another million that they have.

Rob West:
All right. And what is it currently in today?

Caller:
Oh, what they did is they did a lot of it in CDs. So now the CDs are just okay — you know, maybe one or two have, uh, like 1% interest, which is nothing compared to what they had before.

Rob West:
Yeah. Mark, how would you approach a portfolio like this?

Mark Biller:
Yeah, a lot of it, of course, is going to come down to how much risk they want to take. It sounds like they want to be very conservative and that's fine.

You do need to keep in mind, again, what we were talking about earlier, which is that higher yields on these types of savings products like we're seeing today, normally go hand in hand with higher inflation. So on a purchasing power basis with these very, very safe savings-type tools like CDs, like money-market funds that we're talking about today, really at best, you're only maintaining your purchasing power. You're not actually growing your purchasing power over time. In order to grow your purchasing power, you need to step out a little bit further on the risk curve and at least get into that bond funds bucket that we were talking about. If not, you know, mixing in some equities, stocks, that kind of stuff.

So for something like this, James, where they want to keep it very safe, where they don't really need it to grow their purchasing power a lot, I think that maybe going just a step or two out [on] the risk ladder from CDs and money-market funds into — for example, short-term bonds might be a good option. Getting at least part of that into like a short-term bond fund could show a little better return, especially if we are getting towards the cyclical peak in interest rates.

You know, there have been some very clear signals from the Fed over the last few weeks that they are planning to begin to slow their increases in rates. And so that's kind of a clue that we could be nearing the shorter-term peak of that. That of course will help short-term bond funds if those rates can level out at these higher levels because they're making a lot more income now in those short-term bond funds.

And the reason a short-term bond fund is gonna do a little bit better is they're going to branch out typically into a little bit more corporate debt that pays a little higher interest rate. They might be going out, say, three years instead of three months on the types of bonds and debt that they're buying. So they're gonna get a little better interest rate on that. Rob, your thoughts?

Rob West:
Yeah, I like that a lot and perhaps it's a mix of all of these. You have a CD ladder — one, two, and three years — taking advantage of these higher rates, James, with the money-market funds and then introduce the bond funds as maybe a third of this portfolio and just get the overall yield up. We appreciate your call today.

Our final segment with Mark Biller just around the corner. Stay with us. Much more to come.


Rob West:
To Tennessee. John, you're next on the program, sir. How can we help?

Caller:
Yes sir. Good morning, gentlemen. Hey, I have some questions. I own a bunch of real estate, and that's how acquire my living for my family. I own a bunch of rental properties. I'm looking at the market for reinvesting to buy more properties, but I'm looking at interest rates. Where do you see interest rates going in the next six months? I know it's a crystal ball, but where do you see interest rates going? It's about 7.139% right now, but where do you see interest rates? They gonna go back down? Or they gonna back up a little bit further? Where do y'all see in the next six months, gentlemen?

Rob West:
<laugh>. Mark, what are you seeing there?

Mark Biller:
<laugh> Yeah, that's a tough one, John. And I think that the thing you have to be really careful of is this is our first significant inflationary cycle that we have run into — where inflation has gone up by a significant amount — in almost 40 years. So we don't have a lot of practice and neither does this current fed in dealing with it. And that has really shown all the way along. A year ago they were telling us it was "transitory," it was gonna go away. Obviously, that was not the correct call. That's not what happened.

And in the last few weeks or so, there's been another surge of optimism. We've had some good inflation data over the last couple of weeks that is leading a lot of market participants to believe that the worst is over on inflation and it's gonna be coming down now. And that certainly could be the case. But it's still kind of a flimsy hope at this point because we just have not seen enough data to say that that is a definitive trend yet.

And so, given the fact that everybody has underestimated the scope of the inflation all this way up, I'm very hesitant to say, "Yes, we are at the top, it's gonna start coming down and interest rates are gonna follow." I do think that's a decent possibility, but is it something that I would actually want to bank on to the degree of putting money on that in terms of financial decisions that I would be very cautious about. I think we just have to let this play out a little further to see if the Fed really does have a handle on this and has put the cap on this inflation pulse.

The other thing that I think we have to be realistic about is even if it is coming down, is that going to go all the way back down to where we're used to inflation being over the last many years — down to the two 3% range — or is it going to come down but level out at a much higher point?

So a lot of things to think about there. I'm not quite willing to go out on the limb and make a prediction on that there, but hopefully that gives you some things to think about. Rob, your thoughts?

Rob West:
Well, I couldn't agree more. I think you're spot on there. So, John, I think you need to be really thoughtful about how you proceed in considering interest rates at any decisions you're making. Clearly, the trajectory has been up. We're starting to see the Fed perhaps begin to capitulate slightly, at least in their narrative and rhetoric, and we'll see what follows in the days ahead. But this will peak before too long and, clearly, as we start to see inflation coming down, interest rates will follow. John, we appreciate you checking in with us today.

Mark, before we wrap up today, let's talk about the safety of money-market funds. You mentioned earlier in the broadcast that money-market funds, perhaps out of favor as interest rates for now over a decade — until recently — have been hovering around the 0% level, in terms of the Fed funds rate. Now, obviously, quite a bit higher. We need to take another look at these.

For someone considering moving into a money-market fund away from an FDIC-insured savings account, how might they think about the safety of money-market mutual funds?

Mark Biller:
Yeah, you made a great point, Rob, that these bank products, including the online savings accounts come with what's called FDIC insurance, which means that the government will back up those savings accounts and make savers whole if a banking institution were to run into trouble and not be able to pay out the full amount of those savings accounts. The government will step in. And that's the big distinction with money-market funds. They don't carry that insurance.

Now, how much riskier does that make money-market funds? That's an open question. It's been very rare for a money-market fund to not be able to pay out the full amount that investors have had invested in the fund. It did happen once in the financial crisis. There was one money-market fund that "broke the buck" — that's the term because the $1 share price was not able to be paid out when this particular money-market fund ran into trouble.

Now, investors did end up getting back 99% of that 99 cents on the dollar, but they didn't get everything back. And that is an example of the little bit of additional risk that you're taking. I think — and SMI's take has been — that if you stick with money-market funds from big, big financial families that have a lot of reputational risk if they were to let a money-market fund not payout whole, that we think you're probably going to be very, very safe.

And again, that gets back to the fact that the things they're investing in are very short-term debt from very solid institutions. So there's just not a lot of risk there to begin with. Then if you can layer in a big backstop from a big family that has a lot to lose from a reputation standpoint were their money-market fund to fail, then I think you're looking at a pretty safe situation, but not quite as safe as a bank situation with that FDIC insurance.

Rob West:
Yeah. Very good. Well, that's really helpful, Mark.

All right, Mark here in our final moments today, let's just talk about where you see things headed. Obviously, we've had a lot of strength in the market as of late. More recently. I think the market responded positively to the fact that it looks like the Republicans will be in control of the House. That means perhaps more political gridlock, which is good for the market because that means no higher taxes [and] that means perhaps we won't see any further regulation on energy. You know, things staying in remaining status quo from a policy perspective is something the market is attracted to.

That combined with perhaps maybe a softening in the labor market and maybe real data that we're finally seeing inflation begin to come down, all has been positive. Does that mean perhaps the bottom is in? Does that mean perhaps we avoid a recession? What are you thinking at this point?

Mark Biller:
Yeah, all of those things are true, and they all could be very good indications going forward. I wrote for our SMI readers a few weeks ago that we're into what is usually a pretty good seasonal period, and there were two big risks with the Fed meeting and the elections that people were hedged for that are now passed. So all this is good, positive momentum through the end of the year.

I'm still concerned about the potential for a recession in 2023, which kind of puts a lid on my optimism regarding the stock market and where we are in this bear market.

Rob West:
Gotcha. So we still need to stay with a long-term view as always!

Mark Biller, thanks for stopping by. We'll be right back on MoneyWise. Much more to come.