Be A Better Bear: Tactics To Get More Yield For Your Cash

“Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat.”

-Sun Tsu, The Art of War.

Don’t like the way the stock market is trending? Want to hold some cash? Welcome to the club! I’ve been bearish on the markets over the last year and have written extensively about my views. But what hasn’t been touched on as much are the tactics of how to execute a bearish strategy and earn as much money as possible for doing so. Anyone who allocates to cash as an asset class can benefit from using good technique. To these points, the distinction between strategy and tactics is a common concept to have awareness of. In the financial media, 90-95% of the discussion is around stock picking, where stocks are headed next, and overall asset allocation. These are all strategic in nature, leaving many investors with tactical blind spots such as paying too much in commissions, interest, fees, and hidden markups.

For example, let’s say you’ve got a $100,000 account at ETrade and you sold stocks into the summer rally and have been in cash ever since. However, ETrade only pays 0.15% on cash, whereas T-bills and money market funds will soon be paying 5% or more. In the thinking of Chinese philosopher Sun Tsu, such traders are taking the slowest route to victory. Countless customers are in situations just like this, with a $100,000 account leaving $5,000 or more per year in 2023 income on the table. A million-dollar account would potentially leave $50,000 in interest income on the table here under the same circumstances. And this is more common than you’d think.

Bad: Brokerage Sweep Accounts

The default option at most brokerages for your cash is a brokerage sweep account. Most brokerages no longer feel compelled to pay interest to consumers after the 2008 crisis and the resulting zero-interest rate policy over the next 7 years. ETrade pays 0.15%, TD Ameritrade appears to pay 0.3%, and traditional brokerages like Bank of America (BAC) and Fidelity have lousy sweep products as well as decent (but not excellent) money market funds. If you don’t know about money market funds, then the brokerage probably isn’t going to tell you because it’s a huge source of profit for them! If you must use a sweep, Interactive Brokers (IBKR) is a better choice, currently paying about 3.8% annually. Surprisingly, Robinhood (HOOD) actually may also be among the better brokerages in this respect, paying 4% interest for members who subscribe to their “gold” program (or maybe not, as they seem to not be accepting any new accounts for their cash management program).

My unscientific sample of brokerages indicates that most customers who use default sweep accounts would make about 1%, or $1,000 annually off of 100k in cash, although there’s a wide variation in brokers. That’s a terrible deal. Switching brokerages is another tactic that investors should be aware of. This goes beyond commissions and into interest, margin, or any other services that you use as an investor, but your choice of broker has a huge impact on your long-term financial success.

Better: Vanguard Federal Money Market Fund

In almost every case, brokerages are making a spread between what they’re able to earn in interest and what they’re passing along to you as a customer in sweep accounts. So here we use another classic business tactic– cutting out the middleman! Instead of using a default sweep account, park money in a money market fund and pay 11 basis points annually points in fees rather than a spread of 50-500 bps!

Vanguard has a Federal Money Market Fund (VMFXX) that is currently paying a 7-day SEC yield of 4.21%. It’s standard for money market funds to list 7-day yields, which don’t include compound interest in the typical calculation but rest assured, you will earn compound interest in practice and earn compound interest if you reinvest. You need $3,000 for an initial deposit, but the interest earned trumps every brokerage sweep account I’ve seen. Formerly known as the Vanguard Prime Money Market Fund before they dropped everything but government paper, this is a really quick solution to the problem of middlemen taking most of the interest income your cash is earning. It also comes with the perk of avoiding state income and local taxes due to it being written into the US constitution. VMFXX only costs 11 bps per year. Vanguard’s approach is classy here, unlike many brokerages, they’ll put you in a high-quality money market fund by default. I like their money market funds, and you don’t have to have your money at their brokerage to buy them.

Fidelity has money market funds too. However, the one they have (SPAXX) charges 43 bps per year and as such yields 3.9% rather than the 4.2% you can get at Vanguard. No thanks! Schwab too charges 34 bps for their fund (SNVXX), which pulls the yield down. Vanguard’s funds are better!

(Usually) Best: Vanguard Municipal Money Market Fund

In the end, the winning tactic here is not to look at the gross amount of interest paid, but rather what you’re able to keep after paying all your applicable taxes. Money markets have a lot of tax quirks.

The first quirk is that states aren’t allowed to charge interest on federal debt. The second is that the federal government in the US doesn’t tax municipal bonds, but states sometimes do.

The Vanguard Municipal Money Market Fund (VMSXX) is a great pick for this. The 7-day SEC yield is 3.52%. This might not sound like a great deal, but if you’re in the top tax bracket, you’d owe about 40.8% of your marginal investment income to the US in taxes (37% + 3.8% net investment income tax). To actually earn more than you would from a municipal bond at 3.52%, you’d need to earn 5.94% in normal taxable interest. Vanguard also offers California (VCTXX) and New York (VYFXX) money market funds that are exempt from state income tax– upon inspection the New York one looks good but the California one looks a bit weak. This assumes we’re dealing with taxable accounts, if you’re doing this in a retirement account then the munis are useless and you should go with the Federal stuff.

Municipal bonds are often thought of as only for the very rich, but I made a rudimentary spreadsheet (Taxable_Equivalent_Yield_Spreadsheet.xlsx) that you can use to compare yields to see what’s likely to be best for you. I found the breakeven vs. Treasury bills to occur at a net tax rate of about 20%. Your net tax rate is going to depend on your other income, net investment income tax, your deductions, whether you live in a state with an income tax, etc., so you’d want to take your time to figure yours out and/or consult your CPA. My research shows that the breakeven currently occurs for investors with a gross income of around $100k if single and $200k if married. This can get extremely complicated due to deductions, phaseouts, alternative minimum tax, etc., but this is going to be more or less the right number.

If you make less than this, VMFXX is generally better, and if you make more, then VMSXX is better (and better by a huge margin if you’re in the top tax bracket). VMFXX is also better for retirement accounts and non-US investors.

Also Good: Treasury Direct

This comes down to personal preference, but if you want, you can avoid paying Vanguard’s 11-15 bps fees as well by simply investing in T-bills. T-bills can give you extra flexibility to take a little more duration or to match your desired investment horizon. The upside here is that you can make a little more money–3-month T-bills are paying about 4.4% as of my writing this. This would put more money in your pocket if you can avoid paying markups or fees. Treasurydirect.gov (part of the US government) will gladly sell you T-bills without having to deal with a third-party broker. The difference is about $190 per year, but about half of this comes from taking more duration risk than a money market fund so you are giving up a bit of flexibility. Given that the difference between the typical sweep and the Vanguard Money Market Fund is $3200 per year at current rates, this is maybe a perfectionistic move since you get 95% of the benefit with a few clicks of a mouse from going from the typical sweep account to VMFXX or VMSXX, and the remaining 5% from using something like Treasury Direct.

You’d also lose this benefit if you inadvertently pay a markup on T-bills or hidden fees by buying through the wrong broker rather than Treasury Direct. Still, I’d be remiss not to mention T-bills as an option. I-Bonds are also worth secondary consideration as well, but with real yields for Treasuries now positive and inflation cooling, they’re not the slam dunk they were in 2021 and 2022. Similarly, I’ve been told UK investors should take a look at buying gilts at discounts to par, which are exempt from UK capital gains tax.

Money Market Funds Aren’t Risk-Free, But They’re Close

Post-2008, money market funds are implicitly backed by the Fed and the U.S. government, but not explicitly (avoiding moral hazard, or maybe not). During the early days of COVID, there was stress on money market funds and the Fed stepped in to protect the funds without hesitation. Even if they hadn’t, I wouldn’t really worry about Vanguard with this, but several yield-chasing money market funds including the $60 billion Reserve Primary Fund “broke the buck” in 2008 when Lehman Brothers went bankrupt, leading investors in money market funds across the world to panic and for the Fed to step in and backstop the rest of the funds that didn’t have Lehman exposure. Reserve Primary investors got about 99 cents on the dollar back in the end, but after a ton of drama. Similarly, investors who put deposits in brokerage accounts have been occasionally stung, with the highest-profile example being MF Global, whose customers got their money sucked into the firm’s bankruptcy. I believe MF Global customers eventually got their money back, but after a few years (maybe 70 cents on the dollar within 1 year, but a full recovery in 3.5 years). The overwhelming majority of money market funds have never had a problem and never will, and investors who hold their funds at “too big to fail” banks and brokerages should be similarly fine.

Conclusion

Brokerage sweep accounts generally are subpar products, so I’d move your money to a money market fund instead whenever possible. I like Vanguard’s offerings. High-income US investors should give VMSXX a look, while lower-income investors, non-US investors and anyone using a retirement account can park their cash in VMFXX. The optimal solution will vary by individual, but this simple series of tactics can help you earn thousands of dollars per year more in interest than your lazier peers.