Cash Equivalents (T-bills, Money Market)

Treasury bills and money market funds offer risk-free or near-risk-free returns. The 2023–2024 period saw unprecedented yields as the Fed held rates high, creating a genuine opportunity in what is usually the most boring part of a portfolio.

Key takeaways

• T-bill yields rose from 0.1% in 2021 to 5%+ in 2023–2024 after the Fed hiked rates
• Cash equivalents are appropriate for emergency funds, near-term expenses, and portfolio dry powder
• Money market funds have become cost-competitive with savings accounts
• The yield curve inverted, making short-term rates higher than long-term rates—unusual but valuable
• Most long-term investors should hold small cash allocations (5–10% maximum)

The cash boom context

From 2009–2021, cash was a trash investment. The Fed held rates near zero to support the economy after the 2008 crisis. A savings account paid 0.01% APY. A 6-month Treasury bill yielded the same. Money market funds yielded even less. The only way to get returns was to buy equities and accept significant volatility.

This created a psychological bias. If cash paid nothing, it was not worth holding. Many financial advisors argued you should allocate every dollar to stocks and bonds, with zero cash. This made sense in an ultralow-rate environment.

Then came 2022–2024. To fight inflation, the Federal Reserve raised rates from 0% to 5.5% by mid-2023. Suddenly, 3-month Treasury bills yielded 5%. Money market funds with 4.5% yields became accessible to any investor. For the first time since 2008, cash was competitive with long-term bonds.

This created an opportunity. Someone with $100,000 could earn $5,000 per year in T-bills (0% risk) or need to allocate to a 60/40 stock-bond portfolio to get the same return while bearing significant volatility. It made sense to hold some cash.

How Treasury bills work

A Treasury bill is a short-term government debt instrument maturing in 3 months to 1 year. You buy it at a discount and receive face value at maturity. The difference is your return. For example, you pay $98,000 for a 6-month bill with $100,000 face value. At maturity, you receive $100,000. Your return is $2,000 on $98,000 invested, or roughly 4% annualized.

Treasury bills are sold at auction by the US Treasury weekly (for 4-week and 13-week bills) or monthly (for 26-week and 52-week bills). You can buy them directly from Treasury Direct without a brokerage account, or through a bank or brokerage. The interest is exempt from state and local taxes (a small advantage), and there is no default risk—the US government backs them.

The yield on a Treasury bill is the risk-free rate. It represents the rate at which the US government can borrow. When inflation is high and the Fed is fighting it, the risk-free rate rises. When inflation is controlled and the economy slows, the Fed cuts rates and bills yield less. From 2010–2020, T-bills yielded next to nothing. From 2023–2024, they offered genuine competition to stocks and bonds.

Money market funds: what they hold

A money market fund is a mutual fund that invests in short-term, safe securities: T-bills, commercial paper (short-term corporate IOUs), and certificates of deposit. The fund pools the money of many investors and buys a diversified portfolio of these securities. Shareholders own a fractional share of the fund and receive dividends from the interest earned.

Money market funds are extremely safe. They are required to hold securities with an average maturity of 90 days or less and weighted average maturity of 60 days or less. They are subject to strict regulatory oversight. The expense ratios are low, typically 0.20% or less for institutional-class funds.

From a practical standpoint, a money market fund is safer than a savings account, because the fund holds actual government securities and commercial paper, not bank deposits. (Bank deposits are FDIC-insured up to $250,000, so they are also safe, but money market funds are directly backed by securities.)

In 2023–2024, competitive money market funds offered 4.5%+ APY. A $100,000 investment yielded $4,500+ per year with zero stock market risk.

Settlement funds: even simpler cash

Settlement funds (or government money market funds) invest exclusively in T-bills and repurchase agreements backed by T-bills. They are the simplest form of a money market fund. Examples include Vanguard Treasury Money Market Fund (VMFXX) or Fidelity Government Money Market Fund (SPAXX).

Settlement funds in 2024 yield 4.8–5.2%. They are appropriate for:

• Emergency reserves (3–6 months of expenses)
• Dry powder (money waiting to be deployed into equities)
• Near-term spending (college tuition in 2 years, car purchase in 1 year)
• The risk-free portion of a conservative portfolio

The advantage of settlement funds over money market funds is simplicity and safety. You know exactly what you own: US government debt. The disadvantage is slightly lower yield, because you are not earning the credit spread from commercial paper.

The yield curve and why inverted is interesting

The yield curve plots the yields of Treasury securities by maturity. A "normal" curve slopes upward: 3-month bills yield 2%, 10-year bonds yield 4%, 30-year bonds yield 4.5%. The upward slope compensates investors for locking money up longer.

From 2022–2023, the yield curve inverted. 3-month bills yielded 5%, but 10-year bonds yielded only 3.5%. This is unusual and economically significant. It means you could earn more by holding short-term T-bills than long-term bonds—the opposite of the normal risk-return relationship.

An inverted yield curve historically signals a recession is coming (because investors are fleeing to safety). But it also creates an opportunity. An investor with a 5-year time horizon could buy 5-year bonds at 3.5%, or buy 3-month bills at 5%, roll them every 3 months, and likely beat the 5-year bond return (since rates are unlikely to stay at 5% forever, but will eventually normalize).

For a cautious investor, an inverted yield curve made cash allocations genuinely attractive. You could earn 5% with zero risk, and if you are wrong about the economy and a recession comes, you are positioned conservatively anyway.

Where to hold cash: taxable vs tax-deferred

In a taxable account, T-bill interest is taxable at ordinary income rates (federal + state + local), making the after-tax yield lower. If you are in a 37% marginal tax bracket, a 5% T-bill yield becomes 3.15% after taxes.

In a tax-deferred account (401(k), IRA, RRSP, SIPP), T-bill interest is not immediately taxable. The same 5% yield is kept in full. This makes tax-deferred accounts a good place to hold cash.

A practical approach:

• Tax-deferred: Hold 10–20% in T-bills or settlement funds (VMFXX, SPAXX, or Treasury Direct).
• Taxable: Hold emergency reserve in a regular savings account (earning 4%+ in 2024) to avoid state income tax drag. Hold any strategic cash allocation in T-bills if you live in a low-tax state or can offset the tax with investment losses.

Cash allocation sizing

How much cash should you hold? The conventional advice: 3–6 months of expenses as an emergency fund, plus 5–10% of your investment portfolio as dry powder. If your annual spending is $60,000, hold $15,000–$30,000 as emergency reserves. If your investment portfolio is $1 million, hold $50,000–$100,000 in cash and near-term bonds.

During normal times (when T-bills yield under 2%), this cash allocation is a drag. You are earning nothing while stocks compound. But you are building discipline by separating emergency funds from investment funds. During high-rate environments (like 2023–2024), the cash allocation becomes attractive: you earn 5% with zero risk while you wait for better opportunities to deploy cash.

The risk of holding too much cash: you miss equity bull runs. From 2009–2021, if you held 10% cash earning 0.1% while stocks returned 14%, you underperformed by 1.4% per year. Over 12 years, that compounds to significant opportunity cost.

The risk of holding too little cash: you panic-sell stocks during crashes. Many investors who held no cash reserves in 2020 were forced to liquidate equities at depressed prices when the pandemic hit. Those with cash reserves could rebalance into stocks at lower prices, locking in gains when the market recovered.

The 2023–2024 lesson

The cash boom taught a useful lesson: asset returns vary with macroeconomic conditions. When the Fed was expansionary (2010–2021), equities dominated and cash was worthless. When the Fed tightened (2022–2024), bonds declined, equities were volatile, and cash offered a genuine return. An investor who maintained a small cash allocation and rebalanced strategically was rewarded.

Going forward, cash will likely be less attractive. As inflation moderates and the Fed begins cutting rates (probably in 2024–2025), T-bill yields will fall toward 2–3%. This will be less competitive. But maintaining a small cash allocation for optionality is still wise.

Cash in your overall allocation

A typical allocation might be:

• Young, long-term investor: 70% stocks, 20% bonds, 10% cash. Review and rebalance annually.
• Mid-career investor: 60% stocks, 25% bonds, 15% cash. The extra cash provides a margin of safety.
• Pre-retirement investor: 50% stocks, 30% bonds, 20% cash. Increasing cash gives optionality.

Within each bucket, use the highest-yielding alternatives appropriate to your time horizon. Cash for near-term needs (1–2 years) should be in T-bills or money market funds. Cash for medium-term needs (3–5 years) can be in short-term bond funds. Cash for long-term needs (5+ years) should not exist—these dollars should be in stocks or bonds per your allocation.

Decision tree for cash allocation

Related concepts

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