In light of the recent interest rate cut by the Federal Reserve, UBS has indicated that this may not be the last reduction of the year. As a result, investors are increasingly urged to reassess their cash allocations. Currently, there is approximately $7.3 trillion sitting in cash within money market funds, nearing record levels, as reported by the Investment Company Institute. However, with the Fed easing its monetary policy, the attractive rates enjoyed in money markets and cash-equivalent investments are expected to decline.
As of Thursday, the annualized seven-day yield on the Crane 100 list of the 100 largest taxable money funds stood at 4.09%. The Federal Reserve recently lowered the federal funds rate by 25 basis points and hinted at the possibility of two additional cuts this year, plus another in 2026. Should labor market conditions weaken further, additional cuts could occur, according to UBS.
In this evolving financial landscape, the urgency for investors to deploy their cash strategically is becoming increasingly important. UBS research highlights that historically, holding cash has often resulted in underperformance compared to diversified portfolios of U.S. stocks and bonds. Specifically, cash has underperformed approximately 74% of the time on a rolling one-year basis since 1945, and 83% of the time over five-year horizons.
To navigate these challenges, UBS offers a three-pronged approach for managing cash. The first step is organizing liquidity needs. It’s essential not to consolidate all cash in a single savings account or money market fund. Funds required for up to one year should be easily accessible with minimal interest rate risk. UBS recommends a mix of savings accounts, money market funds, or certificates of deposit (CDs), cautioning that early withdrawal from CDs might incur penalties.
The second step involves investing in debt instruments with maturities ranging from one to three years, aiming to balance yield with flexibility. Hoffmann-Burchardi suggests using a bond ladder—comprising individual bonds or fixed maturity bond funds with staggered maturities—to ensure predictable cash flow while managing interest rate risk.
Lastly, for investment cash intended for longer time horizons, such as five years, the focus can shift towards optimizing returns, accepting some price fluctuations and lower liquidity. Hoffmann-Burchardi notes that medium-term government or investment-grade bonds, as well as a diversified bond investment approach, are appropriate. High-quality global bonds may provide attractive opportunities, having surpassed one- to three-month Treasury bills in returns during the period following rate peaks.
UBS also emphasizes the importance of phasing into equities, especially for investors who are currently under-invested in the stock market. By strategically entering positions during market dips, investors can mitigate timing risks. Hoffmann-Burchardi underscores the potential for enhanced gains in global equities driven by lower interest rates, robust earnings growth, and trends in artificial intelligence.
Investors are encouraged to explore sectors that focus on artificial intelligence, power, and resources, which are expected to outperform the broader market in the long term. Additionally, gold and alternative investments are highlighted for their diversification benefits. The precious metal is anticipated to gain from a weaker dollar, lower real interest rates, and investor concerns regarding rising debt levels.
Within the U.S. equity landscape, UBS identifies selective opportunities in dividend-paying stocks. The firm maintains a Global Quality Dividend Payers Index, which includes high-quality stocks that offer attractive dividends. Notable mentions include Johnson & Johnson, yielding 2.99%, and Valero Energy, providing a yield of 2.76%.
In the fixed-income sector, Leslie Falconio, who heads UBS’s taxable fixed-income strategy, highlights agency mortgage-backed securities (MBS) as an appealing option, currently yielding about 5% with high quality and ample liquidity. Despite recent tightening in MBS spreads, they remain attractive compared to long-term averages and investment-grade corporates. Falconio also expresses a preference for commercial MBS, particularly AAA-rated securities, citing the dovish Fed outlook as a favorable factor for the sector’s performance.
As investors adapt to the market’s shifting dynamics, UBS’s insights and strategies may serve as a vital resource for effectively managing cash and capitalizing on growth opportunities.
