The cost of cash: Where to invest when interest rates drop

As interest rates begin to decline, it’s wise to take a fresh look at your cash accounts to ensure they’re still supporting your financial goals.

When rates drop, returns from cash accounts—like money market accounts or CDs—easily can fall behind your objectives. They even can fall behind the rate of inflation. For example, if you earn 2% on a money market account while inflation is 3%, your account balance may grow, but the value of what your money can buy is shrinking. Essentially, you’re losing ground by keeping money there.

To counter this, take a step back and think about what you need your cash to do—both now and in the future. Whether you’re seeking liquidity for immediate needs, steady income or long-term growth, clarifying your priorities and exploring timely strategies can help your cash stay productive and aligned with your goals.

Before changing your cash holdings in response to interest rate shifts, first consider why you’re holding the money and when you’ll need it. Those two factors will help you determine the option that best fits your goals.

• First, consider the money’s purpose. What do you need the money for? Savings intended for a down payment on a home, an emergency fund, college savings or retirement each call for a different approach and type of account.
• Second, consider when you'll need the money. Some goals have clear deadlines like saving for a wedding, a big vacation or an upcoming bill. Others are ongoing or unpredictable, such as building an emergency fund for unexpected car repairs or medical bills.

With purpose and time in mind, you can match your cash with the best tool for the job. Different cash investment alternatives are better suited for different needs. Stable and highly liquid investments may be better for short-term cash needs; for longer-term goals, you may accept higher volatility in exchange for higher yields. Aligning your choice with your goals helps you get the most value from your savings while minimizing risk.

Many people keep their cash reserves in money market accounts or funds—and for good reason. Money market accounts are interest-bearing deposit accounts offered by banks and credit unions, while money market funds are investment products offered through brokerage firms and mutual fund companies. Both options offer the potential of modest returns while keeping risks low.

However, when rates are declining, alternatives like high-yield savings accounts, Treasury offerings and certificates of deposit (CDs) may provide additional value and be better choices in certain situations. Money for short-term goals generally should remain more stable and liquid. For longer-term goals, you may be OK with reduced liquidity so you can get a higher yield.

This table shows how some common options compare and when you might want to use each type:

You have several options for liquid interest-bearing accounts and cash-like investments. They vary slightly in terms of yield, liquidity and stability. You'll need to weigh which combination of those factors is most important to you when deciding where to keep your cash.

Here are choices to consider instead of money market accounts and funds when interest rates are declining:

CDs are time deposits that often provide higher yields in exchange for locking your money into a fixed term such as six months, one year or longer. You’ll typically receive a higher rate on CDs with longer terms. But that also means they are less liquid, since you either need to wait until the agreed-upon term is over or face early withdrawal penalties.

Short-term bond funds are pooled investments that combine many securities into one product. Because you have exposure to the entire portfolio of holdings, it provides additional diversification beyond what you would have by investing in individual bonds yourself. As bonds within the fund mature, they're usually reinvested to keep your money working for you. You also can diversify across different levels of credit quality. Funds that primarily hold bonds with higher credit ratings are more secure but have lower yields. You can earn a little more on your money by investing in funds that hold lower-quality bonds, but there is a greater risk that some of the bonds may default.

Treasury bills are short-term debt obligations of the federal government. T-bills, as they also are called, are highly liquid. They mature in a year or less, and there is also a very active secondary market for them so you can often sell your bill early if you need to. Because they are direct obligations of the U.S. government, they are considered to be extremely safe. An added advantage is that the interest you receive is exempt from state and local taxation.

High-yield savings accounts do not have set terms like CDs and instead function similarly to a traditional savings account. You can deposit and withdraw money at any time without penalty, though there may be minimum balance or other requirements. They provide higher yields than traditional savings accounts and often are competitive with money market funds and money market accounts. Because they do not have a fixed maturity, the amount of interest you earn is tied to current rates and adjusts quickly when rates change. High-yield savings are a good option for emergency funds or other short-term goals that may require quick access to your money.

Laddering refers to purchasing securities with staggered maturities. For example, you may build a ladder by purchasing a security that matures in one year, another that matures in two years and so on. This allows you to match maturities to specific cash flow needs, such as yearly spending needs in retirement or annual college funding. However, if you don’t need the money when it matures, you can simply reinvest it and extend the ladder. You can build ladders with CDs, bonds, T-bills or any other type of financial instrument that has a defined maturity date.

Interest rate movements can have a significant impact on short-term money market instruments. However, each type may respond in different ways. 

• The interest rate on money market funds, money market accounts and high-yield savings accounts adjusts very quickly when the Fed increases or lowers the target interest rate. The rate you receive will go up or down accordingly.
• Treasury bills also adjust, but the current price changes rather than the interest rate you receive. If rates go up, the current price goes down to reflect a greater current yield. These price changes do not affect you if you hold the bill to maturity. However, you may receive a lower rate if you purchase a new bill after maturity, depending on rates in effect at that time.
• Short-term bond funds also can experience small price swings when rates change. The impact depends on the maturity and credit quality of the bonds within the fund.
• CDs do not experience price changes or fluctuating interest rates. Because these are fixed-term, guaranteed accounts, you will receive the contractual rate for the duration of the term.

When evaluating your options, consider the advantages and disadvantages of each. The decision is about more than just finding the instrument with the highest yield. Often, there is a tradeoff between stability and the rate you earn. CDs and Treasury bills generally offer lower yields than other options, but provide certainty if you hold until maturity. High-yield savings may allow you to earn more interest but leave you exposed to changing interest rates. Bond funds also can provide a higher yield, especially when they contain bonds with lower credit ratings, but that comes with increased risk.

Think about your need for stability and how easy it will be to get your money when you need it. While locking in a rate on a CD can be comforting, your money will be less accessible than if it were in a high-yield savings account.

The differences among short-term instruments allow you to match the right cash reserve tool for your personal situation. What you choose should depend on your purpose for the money, the timeframe over which you may need the cash and your comfort level with risk.

• Start by deciding what the purpose of the money is. This could be an emergency fund or a specific purchase.
• Next, decide when you expect to need the money. If it’s in the near term (within a year or so), then a high-yield savings account, money market fund or Treasury bill may be a good choice. Beyond that, you may want to consider CDs or short-term bond funds.
• Throughout the process, remember to consider your risk tolerance. Don’t chase the highest yield if it pushes out of your comfort zone and puts your goals at risk.

Whatever you decide, it’s important to review your choice as your plans or market conditions change. You may find that it’s necessary to shift when they do. A financial advisor can help you ensure that your money remains aligned with your goals and suggest improvements as your circumstances or economic conditions change.

Getting the most value from your cash reserves isn’t about just chasing the highest rate. It's about matching your money’s purpose with the right vehicle. By understanding how different options respond to changing interest rates, you can protect your purchasing power while maintaining the appropriate liquidity for your needs. Proactively monitoring interest rate trends, reviewing your allocations and goals regularly and adjusting when appropriate allows you to remain on track.

A Thrivent financial advisor can help you create a thoughtful strategy that ensures your cash reserves are optimized to best support your goals.