I'm sure this goes without saying, but the financial landscape is always changing. A large part of the reason is that investors' preferences change as they try to find the best way to maximize returns. This year has been no different, with rising interest rates making money market funds more attractive.
In 2023 alone, investors have put around $756 billion into money market funds, according to a recent report from Bank of America. With such an influx of cash headed into these funds, many investors may wonder if they should follow suit. Like most other financial questions, the answer is: It depends.
Why money market funds? Why now?
To fight rising inflation, the Federal Reserve began increasing interest rates, making it more expensive for banks and financial institutions to borrow money. These higher interest rates also trickle down to consumers. The bad news is that interest rates on debt like mortgages, car loans, and credit cards increase. The good news is that interest rates offered on certain investment products also increase.
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Money market funds are investments that benefit from these higher interest rates. They invest in short-term debt instruments, allowing investors to earn more on their investments with relatively low risk and high liquidity.
Should you leave stocks for money market funds?
In the same report, Bank of America noted that the stock market had $3.9 billion in outflows -- the third consecutive week of drops. Before completely jumping ship from stocks to money market funds, investors should first consider their long-term financial goals. It can be easy to get caught up in current attractive interest rates, but that may not be what's in your best interest.
If your goal is to grow your money as much as possible before retirement, abandoning stocks would likely be counterproductive because of potential future gains missed.
Suppose you put $10,000 into a money market fund with a 5% APY. If we assume you earn compound interest and the APY remains the same, it would take over 14 years to double the investment. For perspective, the S&P 500 (^GSPC -0.27%) is up over 440% since the dot-com bubble crash; it took it less than four years to double after the 2007 to 2009 Great Recession, and it's up over 80% from pandemic lows, even after dropping over 18% in 2022.
To be fair, it's easier to make this point in retrospect after the results have happened. You can't predict what the stock market will do, but even if we assume it gets worse before it gets better, it's a safe bet that it will get better. And when it does get better, history has shown the results from it usually far outweigh what could be accomplished with a money market fund over that span.
Your time horizon matters
For investors nearing retirement, a partial shift toward money market funds makes more sense because they offer stability, liquidity, and predictable returns. As you approach retirement, you don't want too much of your portfolio exposed to the volatility of the stock market. Money market funds provide a safer alternative and much better returns than many traditional savings accounts.
Conversely, most younger investors with time on their side should lean on stocks. The stability and low risk of money market funds are enticing, but they don't have the same potential for long-term gains as stocks. With a longer time horizon, the goal should be growing your money as much as possible.
The answer for you might be different from the answer for me. More than anything, it's important to do what you're comfortable with and what aligns with your goals and risk tolerance.
