Cash’s Heyday Is Coming to an End. What to Do Next.

Bond yields have already moved in anticipation of Federal Reserve rate cuts. (Dreamstime)

Expectations for a September rate cut have soared, and retirees parked in cash may want to act now before they lose opportunities both in cash and the bond market.

The odds of the Federal Reserve cutting interest rates at its September meeting have risen to 93% after weak jobs data for July took investors by surprise. The Fed has been on pause since December, as inflation has remained above its target of 2% and the labor market had largely held steady. Cash yields have remained in the 4% vicinity, leaving investors less incentive to take on the additional risk of venturing into stocks or bonds.

But these yields will fall if the Fed cuts its benchmark interest rate as expected, and investors who are overallocated to cash shouldn’t wait until that happens to rotate into bonds, experts say. “For anyone who’s in cash right now, you probably want to make the move sooner rather than later if you think the Fed will cut,” says Michael Landsberg, a Certified Financial Planner at Homrich Berg Wealth Management in Atlanta.

Don’t exit completely, of course: Most advisors recommend that retirees maintain a cash allocation of at least a year’s worth of living expenses to cushion immediate needs from market gyrations. That should be in a liquid account, while intermediate-term expenses could go into a certificate of deposit. The top yields on two-year CDs are still above 4%, and if you’ve been considering a purchase, now’s the time to lock in those rates, says Greg McBride, chief financial analyst at Bankrate.

While yields on cash products generally track Fed movements, the central bank more directly influences short-term Treasury bills and other bonds on the short end of the curve. Long-term bond yields hinge more on prospects for inflation and economic growth. Yields move inversely to prices, and when yields fall, existing bondholders will see a boost in the prices of their holdings. Those who cling to cash will face a higher cost of entry into bonds after that happens.

To be sure, yields have already moved in anticipation of Fed action. Yields on the 10-year T-bill dropped 0.14 percentage point to 4.2% on Aug. 1, following the jobs report. But there’s room for more declines, bond pros say, with the market pricing in the likelihood of at least two cuts before year end. The short end of the yield curve will likely see a steeper decline than the longer end.

Many pros see the best opportunities in intermediate durations of between three and five years. The iShares Core U.S. Aggregate Bond exchange-traded fund offers easy exposure to U.S. investment-grade debt, with a current effective duration of 5.8 years and a yield of 4.4%. The iShares Flexible Income Active ETF offers farther-ranging exposure to global and high-yield bonds, with an effective duration of 3.6 years and a yield of 5.2%.

Corbin Grillo, director of investment strategy at Linscomb Wealth in Houston, takes a core-and-satellite approach to fixed-income portfolios. One core holding is the Baird Aggregate Bond fund, which he pairs with the multisector Pimco Income fund.

Linscomb Wealth’s clients currently have a classic portfolio split of 60% stocks/40% bonds at retirement. While the memory of bonds’ 13% plunge in 2022 remains fresh for many investors, conditions were very different then. This year has been a solid year for fixed income so far, with the Bloomberg Aggregate index returning 4.8%.

Bonds held their own during the “Liberation Day” stock plunge in April, Grillo says, noting that today fixed income is “at least a lot closer to serving as ballast” in portfolios.

Write to Elizabeth O’Brien at elizabeth.obrien@barrons.com