Investors clinging to cash face these two risks as the Fed cuts interest rates, researchers say

By Joy Wiltermuth

Researchers looked at how much $1 million invested in cash would have earned versus stocks over almost 100 years

Investors able to earn 5% on "cash" without taking a whole lot of risk have been pretty unwilling to give up on the strategy, even as the Federal Reserve starts cutting interest rates.

Money-market funds, a popular type of cash investment since 2022, held more than $6.3 trillion in assets as of last week, even after the Fed's big rate cut of 50 basis points last week.

But that strategy also comes with "reinvestment risk," where investors find far fewer places to earn 5% without taking on significantly more risk, especially as the bond market recalibrates to lower interest rates, according to the Wells Fargo Investment Institute.

Michelle Wan, a global investment strategist at the firm, thinks the time may have come for investors to reduce their cash-alternative allocations in favor of "intermediate" fixed income, such as residential mortgage-backed securities and U.S. municipal bonds.

The strategy can "help investors secure coupon income and potentially benefit from asset-price appreciation once market interest rates decline during our tactical timeframe," Wan wrote in a Monday client note.

Another risk is the "cash drag," according to Wan, who along with a team studied how much $1 million invested in riskier assets outperformed cash and cash alternatives since 1926.

They found that small-cap equities RUT increased the $1 million the most over that stretch, to $62 billion, while large-cap stocks reached $21 billion and Treasury bills - a cash alternative - grew to $24 million.

Stocks edged deeper into record territory on Monday, with the Dow Jones Industrial Average DJIA up 0.15%, the S&P 500 SPX 0.28% higher and the Nasdaq Composite COMP up 0.14%, according to FactSet.

-Joy Wiltermuth

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09-23-24 1929ET

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