Why Should We Own Bonds Instead of Cash?

Why Should We Own Bonds Instead of Cash?

March 14, 2024

Money market interest rates are higher than they’ve been in many years, largely as a result of the Fed’s campaign to tackle persistent inflation.  While money market mutual funds are not risk free, there’s no question credit risk and share price volatility are lower with money markets compared to traditional bond mutual funds.  With that in mind, why wouldn’t we recommend using money markets in place of bonds in our investment portfolios?

Cash and money markets certainly have an important role to play in a well-structured financial plan.  It’s important to maintain a cash reserve, outside of our investment portfolios, for emergencies and large upcoming planned expenses.  Without a sufficient cash reserve, we may need to go into debt or withdraw from retirement savings prematurely in order to handle a large unforeseen expense, both of which could negatively impact long-term financial security. 

But traditional bond mutual funds are preferred to money markets for retirement savings and long-term investments for a variety of reasons:

  • Inflation: Inflation greatly reduces the purchasing power of cash over time, but traditional bonds historically hold up much better against inflation.  A recent study by Nuveen, a mutual fund company, shows that over rolling 30-year investment horizons since 1928, cash lost money to inflation nearly one-third of the time, whereas bond returns failed to beat inflation only 15% of the time.
  • Two potential sources of return instead of one: In addition to offering a stream of income, bonds have the potential to appreciate over time if interest rates decline, whereas cash only has income potential.  In a declining rate environment, most bond funds should experience some share price appreciation which can add a tailwind to overall portfolio returns and also offer a buffer should stocks experience a rocky patch.
  • More consistent income and return: So why not just hold money markets temporarily and then switch back to bonds in the future?  The question then becomes when to make that switch.  If you wait for money market rates to go down, you will likely miss the appreciation taking place in bond funds as interest rates fall.  As we know, market timing is not a strategy that can be successfully reproduced over time, and factors that impact the bond market in particular, and the interest rate environment overall, are complex and fast moving.

While it’s important to maintain a cash reserve for the unexpected, traditional bond mutual funds are typically the best long-term vehicle for the fixed income portion of diversified investment portfolios.

The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding investments, sectors or markets in general. 

The above statistics and/or commentary has been obtained from sources we believe are reliable, but we cannot guarantee their accuracy or completeness.  Past performance is no guarantee of future results. 

Specific securities discussed herein are illustrations and do not represent securities purchased, sold or recommended for client accounts.  Such information does not constitute, and should not be construed as, a recommendation to buy or sell specific securities.

This is not a complete analysis of every material fact regarding any company, industry, or economic condition.  Due to shifting market conditions, all expressions of opinion are subject to change without notice.

Talk to your financial advisor before acting on information in this document.