The Risks of Carrying Cash as Rates Fall By Investing.com

Investing.com — Growth in money market fund assets, which have hit record levels, is exposing investors to reinvestment risks as the Federal Reserve heads into a rate-cutting cycle.

While holding cash has provided steady returns in recent years, investors may now face diminishing returns as interest rates fall, creating a challenge to reinvest with comparable returns, Wells Fargo strategists noted in a recent report .

Reinvestment risk is a key concern. Investors currently earning nearly 5% on cash positions in money market funds may struggle to find similar low-risk options with equivalent returns as rates continue to fall.

When we talk about the long term, another risk arises – pulling cash on portfolio performance. Historically, riskier assets such as stocks have significantly outperformed cash. Wells Fargo’s analysis shows that a million dollars invested in small-cap stocks in 1926 would have grown to $62 billion, while the same investment in Treasury bills, a common alternative to cash, would have grown to just $24 million dollars during the same period.

“On a risk-adjusted basis, as measured by Sharpe ratios, our study of long-term capital market assumptions shows that US equities have outperformed long-term cash returns,” the report said.

“The strength of compound returns has generally benefited riskier assets such as equities, leaving cash at a disadvantage for long-term investors. We therefore caution investors to avoid cash as a long-term investment strategy or significant allocation.”

For investors reconsidering their large cash portfolios, Wells Fargo advises diversification across asset classes to balance risk and return.

While it may be tempting to move aggressively into higher-risk assets, the report suggests that strategic reallocation, such as dollar cost averaging in a diversified portfolio, can provide upside potential while mitigating risk. This approach can help investors navigate the risks associated with falling interest rates while positioning themselves for long-term financial goals.

The stock market has seen significant volatility in recent months. The value fell from around 5670 to 5150 between July and August before climbing back up to near 5650 by the end of August.

It then fell to around 5400, followed by a return to all-time highs. That volatility was largely driven by a battle between concerns about a potential recession and hopes for a soft landing.

Contributing factors include the slowing economy, changes in monetary policy and upcoming elections. Some are now wondering if an economic or income recession is ahead.

However, strategists at Wells Fargo believe the current outlook suggests a mild slowdown rather than an outright recession, with a recovery expected by the end of 2025.