In a dramatic shift from the past decade of near-zero interest rates, American investors are now capitalizing on the rising yields from money-market funds and other cash-like instruments. The Federal Reserve’s aggressive campaign to increase interest rates and curtail inflation has effectively challenged the long-standing belief that stocks are the only viable investment option. Indeed, following the stock-market selloff last year, many investors are finding comfort in the 5% return offered by these less risky alternatives.

This change in investment strategy has been particularly noticeable amongst individuals like Keith Hagg, a 50-year-old lawyer who previously held most of his portfolio in equities. Hagg’s recent move towards "stockpiling cash" in money-market funds and allocating more to bonds reflects a broader trend among investors. Despite a surprising rebound in the stock market this year, the rally has stalled recently, with the S&P 500 down by 4.8% in August. This has led to an anticipation of further interest-rate increases, as economic indicators continue to show strength.

Interest Rates Shift Ushers in New Investment Paradigm

A Decade-Long Dry Spell Ends

After enduring an extended period of ultralow interest rates, American investors now find themselves in a vastly different landscape. Gone are the days of earning close to zero on checking or savings accounts. The Federal Reserve’s aggressive interest-rate-raising campaign has created a novel paradigm where cash-like instruments such as money-market funds are providing attractive returns, shifting the long-held belief that “there is no alternative” to stocks.

Investors Diversify Portfolios

Keith Hagg, a 50-year-old lawyer, is one of the many investors who are rethinking their investment strategies. Previously, equities formed a significant portion of his investment portfolio. However, with the rise in yields, Hagg has been reallocating his investments to money-market funds and bonds, finding value in the robust returns. Hagg’s shift in investment strategy comes amidst an environment where the S&P 500 fell 4.8% in August, and there is the potential for further interest-rate increases as the economy continues to show signs of strength.

Follow the Money

Data from Refinitiv Lipper reveals a significant shift in investment trends. Over the past five weeks, investors have pulled $11.6 billion from stock funds, while injecting a net $91.1 billion into money-market funds. The hunt for yield is leading investors to various avenues. For instance, Treasury bonds are considered safe assets with little default risk, although they still bear interest rate and inflation risks. The current yield curve is inverted with short-term bonds yielding more than longer ones. For instance, the one-month Treasury bill yields 5.37%, while the 30-year bond offers just 4.38%.

Money-Market Funds Surge

Retail money-market funds, which function like bank accounts and hold only high-quality, liquid assets, have seen significant growth this year. According to Federal Reserve data, cash in these funds has grown by over 25% to $1.5 trillion. The average yield on the 100 largest taxable money-market funds reached 5.15% – the highest since 1999. Kevin Barker, another investor, has sold most of his stockholdings and moved his cash to a Schwab money-market mutual fund, which yields over 5%.

Dividend Stocks and Junk Bonds

In addition to money-market funds and Treasury bonds, investors are also considering high-dividend stocks and high-yield corporate bond funds. Despite being riskier, these options can provide sizable income after fees. However, Refinitiv Lipper data shows that around $11 billion has been pulled from high-yield corporate bond funds this year.

Takeaways

This shift in investment trends indicates a significant change in the investment landscape, driven by the Federal Reserve’s aggressive interest-rate-raising campaign. While equities have traditionally been a popular choice for investors, the newfound attractiveness of cash-like instruments and high-yield options is causing a reevaluation of investment strategies. However, these trends also signify the importance of diversification in investment portfolios to mitigate risks. As interest rates continue to rise, it will be interesting to see how these trends evolve.