Picture this: It’s the end of the year. You’ve worked hard, hit your targets and now the bonus lands in your account – or maybe you’ve sold a business, liquidated an investment or simply received an unexpected windfall.
No matter how you got the cash, the question comes loud and fast: What do you do with it?
Everyone has their own goals, like a big vacation, a new home or just the thrill of seeing a bigger account balance on the screen. In other words, the options may seem endless when you receive a cash bonus – some may choose longer-term options, such as opting to invest in real estate, putting it into a retirement account or simply stashing it away for emergency use.
But before you spend or sit on it, there’s a potentially smarter move: You can turn that extra cash into a tool that works for you. This is where liquidity options come in, which is how you can put your year-end bonus cash to work in the short term. It’s not just about stashing cash somewhere safe but more so about using the right mix of liquidity options – money market funds, Treasuries, brokered certificates of deposit (CDs), short-term bond funds, municipal bonds and even high-yield savings accounts (HYSAs) – to preserve capital, stay flexible and earn income.
Think of liquidity investing like perusing a buffet – ideally, you want balance, variety and flexibility, depending on your appetite and timing. Here are the main options:
Money market funds
Money market funds invest in short-term, high-quality debt securities. Some of these funds may also offer tax-advantaged investments, such as those holding U.S. Treasuries or municipal securities, which can provide federal or state tax benefits depending on your location and tax status.
Types of money market funds
- Prime funds invest in a mix of corporate and government securities, typically offering higher yields but with slightly more risk.
- Government funds invest primarily in U.S. Treasuries and government agency securities, providing maximum safety and liquidity.
- Retail funds are designed for individual investors, often with features tailored to personal cash management needs.
What can money market funds offer?
- High liquidity: Funds can typically be accessed within one business day.
- Capital preservation: Money market funds aim to maintain a stable net asset value (NAV).
- Yield sensitivity: Yields adjust quickly to changes in interest rates.
What are the risks of money market funds?
- Loss of principal: Money market funds aim to maintain a stable share price, but it is possible that they may lose value in periods of high market stress, and they are not insured or guaranteed.
- Interest rate risk: When short-term rates move significantly, the value of the securities in the fund and the income the fund distributes can change quickly.
- Credit risk: Even with high-quality holdings, there’s a possibility that an issuer fails to make payments on time, which may lead to losses or reduced yield for the fund.
- Liquidity and regulatory risk: Large investor redemptions or changes in money market regulation may result in a fund having to sell holdings at less-than-ideal prices or adjust its structure, potentially affecting returns and access to cash.
Municipal bonds
Municipal bonds are issued by state and local governments to fund public projects. For liquidity purposes, short-term municipal bonds or municipal money market funds can be a sensible option. In a falling rate environment, existing municipal bonds may appreciate in value, and new issues will offer lower yields. For those seeking tax efficiency, short-term municipal bonds can be a valuable addition to the liquidity sleeve of a portfolio.
What can municipal bonds offer?
- Tax advantages: Interest income from municipal bonds is generally exempt from federal income tax and may also be exempt from state and local taxes for residents.
- Favorable risk profiles: Many municipal bonds are highly rated, even though credit risk varies by issuer, and tend to be more stable than securities like stocks.
- Liquidity: Short-term municipal bonds and municipal money market funds offer reasonable access to funds, though not as immediate as other money market funds or Treasuries.
- Yield: Yields may be lower than taxable alternatives, but after-tax returns can be attractive for investors in higher tax brackets.
What are the risks of municipal bonds?
- Credit risk: Municipal issuers could experience budget issues with their projects that may affect their ability to make interest payments on time.
- Interest rate and market risk: Municipal bond prices move in response to changes in interest rates and investor demand, so selling before maturity could result in proceeds that may be higher or lower than the original purchase price.
- Tax and policy risk: Some municipal bonds are subject to the alternative minimum tax, and future changes in tax law or state and local rules may reduce the value of their tax benefits.
- Liquidity risk: Certain municipal issues trade infrequently, which could make it harder to sell quickly at a desired price, especially in periods of market stress.
- Call risk: Many municipal bonds are callable, meaning the issuer can choose to redeem them before their stated maturity date. Issuers may call municipal bonds early when interest rates fall, allowing them to refinance at a lower borrowing cost. In this situation, investors have to reallocate their funds in a lower-yield environment.
Short-term bond funds
Short-term bond funds are mutual funds that invest in bonds with maturities that typically last less than three years. Short-term bond funds may also include portfolios of Treasuries, corporate or municipal bonds, offering potential tax benefits similar to those found in money market funds.
What can short-term bond funds offer?
- Higher yield potential: Compared with money market funds, short-term bond funds may offer slightly higher yields.
- Modest interest rate risk: Short-term bonds limit price volatility, but some risk remains.
- Diversification: Short-term bond funds expose investors to a range of issuers and sectors.
What are the risks of short-term bond funds?
- Interest rate risk: Even with shorter maturities, bond prices in the fund may fall when interest rates rise, which could cause fluctuations in the fund’s net asset value.
- Credit risk: Short-term bond funds can hold corporate, asset-backed or mortgage-backed securities that carry credit, extension and prepayment risks, which can increase price volatility relative to government bills.
- Liquidity risk: In stressed markets, some underlying bonds may become harder to trade, which could widen bid-ask spreads and possibly affect the price at which fund shares are bought or sold.
- Not insured: Short-term bond funds are investment products, not bank deposits, so they are not insured by the Federal Deposit Insurance Corporation (FDIC), and investors may lose money.
Treasuries
U.S. Treasury securities are considered to potentially be one of the safest fixed-income investments. For liquidity purposes, Treasury bills (T-bills) and notes with maturities under three years are most relevant. In a falling rate environment, existing Treasuries may appreciate in value, but new issues will offer lower yields. Laddering Treasuries – or buying securities with staggered maturities – can help manage reinvestment risk.
What can Treasuries offer?
- Safety: Treasuries are backed by the full faith and credit of the U.S. government.
- Liquidity: You can buy and sell Treasuries relatively easily in the secondary market.
- Yield: Treasury yields are typically lower than other options, but they are often fairly predictable.
What are the risks of Treasuries?
- Interest rate risk: Treasury prices typically fall when interest rates rise, potentially impacting investors’ asset values.
- Reinvestment risk: When bonds mature in a falling rate environment, the proceeds may need to be reinvested at lower yields.
- Market and policy risk: Treasuries typically trade in deep markets, but periods of policy uncertainty or debt ceiling debates could add volatility to prices and yields over short time frames.
Brokered CDs
Brokered CDs are issued by banks but purchased through brokerage firms. In a falling rate environment, locking in rates with brokered CDs can be attractive, especially if rates are expected to decline further. However, early withdrawal may not be possible without selling on the secondary market, which could result in a loss if rates have moved unfavorably.
What can brokered CDs offer?
- FDIC insurance: Brokered CDs are insured by the FDIC up to applicable limits.
- Fixed maturity dates: Maturity dates typically range from a few months to three years.
- Potentially higher yields: Yields may be higher compared with traditional bank CDs.
What are the risks of brokered CDs?
- Interest rate and price risk: Brokered CDs trade in the secondary market, so their prices move with interest rates. Selling before maturity may result in a gain or a loss.
- Call and reinvestment risk: Many brokered CDs are callable, which means the issuing bank could redeem them early. Investors then typically need to reinvest proceeds at available rates, which may result in lower yields.
- Liquidity risk: Accessing your funds before the CD maturity date often requires finding a buyer in the secondary market, which may not be possible.
- FDIC coverage limits: FDIC insurance applies only up to standard limits per depositor per insured bank, so balances above those thresholds will be exposed to issuer credit risk.
High-Yield Savings Accounts (HYSAs)
As their name suggests, HYSAs are bank accounts that pay attractive yields on your deposits. Yields on HYSAs will adjust downward as rates fall, but they remain a flexible and safe option for short-term cash management.
What can HYSAs offer?
- Daily liquidity: Funds can be accessed at any time.
- Competitive yields: Yields are often higher than traditional savings accounts.
- FDIC insurance: HYSAs are insured by the FDIC up to applicable limits.
What are the risks of HYSAs?
- Variable rate risk: Banks can change rates at any time, potentially impacting the yield on your savings account.
- Account and access limitations: Some HYSAs come with transaction limits, minimum balance requirements or other terms that could restrict flexibility for frequent transfers.
- Deposit insurance caps: FDIC insurance only applies up to standard limits per depositor per institution, so amounts above those levels will be exposed to bank credit risk.
When a cash bonus is coming down the line, you may consider the following strategies, especially in a falling rate environment like the one we’re in currently.
1. Assess liquidity needs
Determine how much cash needs to remain immediately available versus what can be invested for a slightly longer term. Money market funds and HYSAs are ideal for immediate needs, while short-term bond funds, Treasuries, brokered CDs and municipal bonds can be used for money that isn’t needed right away.
2. Lock in rates where appropriate
If rates are expected to continue falling, consider locking in current yields with brokered CDs, short-term Treasuries or municipal bonds. Remember that new bonds will be issued at lower rates, so consider locking in for longer to a level that is appropriate for you.
3. Diversify across instruments
You may want to spread cash across multiple liquidity investments to balance yield, risk and access. For example, a mix of money market funds, short-term bond funds, brokered CDs, Treasuries and municipal bonds can provide both flexibility and income.
4. Monitor reinvestment risk
Keep in mind that maturing investments may need to be reinvested at lower rates. Laddering maturities and maintaining a mix of instruments can help mitigate this risk.
5. Stay informed and flexible
Interest rate environments can change quickly. Regularly review your portfolio and be prepared to adjust allocations as conditions evolve.
While there are many things you can do with bonus-time cash, it’s worth remembering that these liquidity options are designed primarily to preserve value in the short-term space. Liquidity strategies can act as a financial bridge to keep your money safe, accessible and productive while you evaluate the bigger picture. As you identify goals with longer time horizons, the conversation may shift, and your advisor can help transition part of your bonus cash into longer-term strategies that may include equities, alternative investments or fixed-income assets with longer-term maturities – all of which can be aligned with your overall wealth plan and financial goals.
What could you do with your investments?
Given the current outlook for falling interest rates and the prospect of a year-end cash bonus, you may consider:
- Prioritizing liquidity and safety for funds needed in the short term.
- Exploring locking in yields on short-term instruments before rates fall further.
- Diversifying across money market funds, short-term bond funds, Treasuries, brokered CDs, HYSAs and municipal bonds.
- Working with your financial advisor to tailor your strategy to your specific goals, risk tolerance and cash flow needs.
Why liquidity decisions matter as interest rates change
Think of interest rates as the heartbeat of your portfolio. When the Federal Reserve (Fed) hikes rates, the whole ecosystem of cash, bonds and borrowing changes. Over the past two years, investors have enjoyed some of the best yields on cash in over a decade. But with the Fed shifting toward rate cuts, that landscape is changing.
Here’s what this could mean for investors:
- Lower yields on new investments. As rates come down, newly issued CDs, Treasuries and money market funds will pay less.
- Potential price gains in bonds. Short-term bonds with higher coupons may gain value.
- Reinvestment risk. That great 5% yield you locked in six months ago? When it matures, you may have to settle for less.
What could happen if the Fed pauses rate changes?
If the Fed decides to pause rate changes, the market may experience a period of uncertainty and recalibration – yields on new liquidity investments are likely to remain steady, but investors may see increased volatility in both bond and equity markets as participants digest mixed economic signals. For portfolio allocations, maintaining flexibility and diversification becomes even more important as the path forward for rates – and the broader economy – remains unclear.
So, when you get a big bonus or windfall now, the decision isn’t just where to put it – it’s also when and how long to lock in yields.
If you’ve received a big year-end bonus or other cash windfall, this is likely a good window to act. Rates are poised to head lower, and the choices you make now could define the income you earn on that cash in the following years. As always, you may want to consult with a financial advisor to ensure that your liquidity strategy aligns with your overall financial goals.
