How the Federal Reserve Affects Your Short-Term Investments
Michael Dombrowski
Key Takeaways
Immediate Impact on T-Bills: US Treasury Bills (T-Bills) adjust their yields almost immediately following Fed rate changes due to weekly auctions.
Gradual Changes in Short Duration Funds: Funds like Morgan Stanley's MULSX adjust their yields more slowly, benefiting from a diverse range of short-term bonds.
Delayed Adjustments in Money Market Funds: Money market funds experience yield changes only as old securities mature, limiting investor control over their returns.
Investment Risks: All short-term investments carry risks, including potential principal loss, and are not FDIC insured.
The Bottom Line
When the Fed changes interest rates, your short-term investment yields will change. But the timing of those adjustments varies by asset.
These changes affect all investors and the market, so no short-term holding is immune. Let's now examine the timing of these changes.
US Treasury Bills: The Speed Demon
Treasury Bills (T-Bills) tend to respond to Fed rate changes the quickest. These are short-term loans to the US government lasting anywhere from a few weeks to a year. T-Bill rates adjust almost immediately and, in some cases, before the Fed announcement.
This happens because T-Bills are sold at auctions every week. And buyers price them based on current market conditions. So if you're investing in T-Bills, you'll see the impact of Fed decisions right away - for better or worse.
Short Duration Funds: The Casual Stroll
Funds like Morgan Stanley's MULSX (Ultra-Short Income Portfolio) will change, but at a more casual pace.
These funds invest in various short-term bonds from corporations, banks and the government. Due to the short effective duration of the holdings. Funds like MULSX move at a slow pace making them attractive.
These funds have the advantage of investing in a broad range of assets, paying extra interest above government securities. This extra bond income helps the yield change at a slower pace than T-bills and money market funds.
Money Market Funds: The Watch and Wait
Money market funds don't change their rates overnight. This can work for or against investors.
These funds hold a mix of short-term securities that mature in about 30 days. So when the Fed changes rates, the fund's yield will change as old investments mature and new ones are bought.
Unfortunately, this means investors are stuck watching their yield change with no input. When rates are going lower, they have no way to lock in preferred rates. And when rates are going higher, investors only get what the market can provide.
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