When clients are obsessed with cash yields, what do you tell them?

It’s commonly understood that limiting the amount of cash investors keep on the sidelines can help long-term returns. However, in the short term, it can be challenging to set cash allocations, as clients weigh the need to be fully invested with life’s complexities.

While most investors allocate a portion to cash as a consistent exposure, differences in lifestyle, stage of life, as well as market expectations can all influence how much cash is needed. And today’s higher rates create an even stronger desire to maintain a larger cash allocation. But what role should it play in portfolio construction?

Cash is obviously needed for immediate obligations, such as groceries, but it can also play a stabilizing role in portfolios—both of which can make cash very important.

Integrating cash into a financial plan has become more complex with the advent of vehicles, such as short-dated fixed income ETFs, which can help investors prepare for liquidity events, added to a pre-existing menu of financial instruments, including bank accounts, CDs, and money market funds.

To help cut through the clutter, we’ll examine cash and liquidity in two ways. First, we’ll consider liquidity assets that don’t need to be spent immediately as strategic. Second, we’ll call assets that need to be spent immediately or in the near future functional.  

Setting goals: The cornerstone

Unpacking all the nuances of how to optimize liquidity positions in a portfolio starts with your clients setting clear goals. What are their spending needs now, and what will they be in the future? Key considerations include:

1. Maintaining liquid funds for things like groceries or monthly mortgage payments.
2. Keeping an emergency fund for life’s surprises, including home repairs or medical expenses.
3. Factoring in desired discretionary expenses for vacations or even luxury items.
4. Planning systematically for giving to heirs or charity

Once these goals are set, the looming question is the timing around when such expenditures come due. Determining this requires us to revisit the distinction between strategic liquidity and functional liquidity.

A strategic liquidity allocation

When investors are accumulating assets, cash and short-term bonds can act as a volatility dampener in a portfolio. This can be a welcome attribute for investors with a lower risk appetite who seek to preserve their wealth.

To be sure, holding excess cash for too long carries its own risks, including missing market rallies, failing to keep pace with inflation, and, not least, falling short of asset-accumulation goals.

If, despite the possibility of holding too much cash over the long haul, a strategic allocation to lower volatility and highly liquid assets remains a priority, it’s crucial to understand that changes in the investment landscape have made short-dated and ultra-short-dated bond ETFs a viable choice for investors keen on preserving wealth.

These ETFs are low-cost, have limited volatility, are highly liquid, and often offer more attractive yields than historically popular cash instruments, such as bank accounts, CDs, and money market funds.¹

A functional allocation to cash and cash alternatives

Once investors begin to spend their accumulated assets, liquidity assets then assume a more functional role. This functional phase has several considerations, which, when combined, represent another opportunity for advisors to add value to clients.

 The functional aspects of cash allocation include three distinct tiers:

1. Planned spending within the next 1–2 years.
2. Upcoming spending within the next year.
3. Immediate spending within the next one to two months

As the spending goal approaches its due date, it moves—functionally—to the next bucket on the list until that sum is only held in immediately spendable cash.

The vehicle matters

When investors consider cash, many may still be using savings accounts, checking accounts, CDs, and money market funds. But in many cases, these historically popular cash choices can have significant shortcomings.

Investors who favor these vehicles may achieve the capital preservation they desire, but in the process, they may also have to forgo meaningful return, liquidity, or yield.

Bank accounts tend to have very low yields; alternatively, CDs may sometimes offer decent yields, but they’re not liquid and can’t be accessed immediately. That doesn’t bode well for a client who has found their dream retirement home a year earlier than expected.²

And finally, there are money market funds, which can offer attractive yields as well as liquidity. However, some investors lack access to high-quality money market funds, and their average expense ratio remains relatively high at 23 basis points, which can erode their attractive yields.³

Integrating bond ETFs into cash allocations

In the context of these varied drawbacks, ultra-short and short-term bond ETFs can make a difference for investors seeking to maximize yield within their lower-volatility positions.

While they may not offer the immediate access and capital preservation characteristics of other vehicles, their low volatility, low cost, and high liquidity give investors a potentially valuable tool for managing their liquidity needs.

Most importantly, they can be used to tier liquidity needs as clients reach their investment goals.

They come in multiple varieties as well, from index strategies offering Treasury bills such as Vanguard 0-3 Month Treasury Bill ETF (VBIL) and Vanguard Ultra-Short Treasury ETF (VGUS), to active strategies including Vanguard Ultra-Short Bond ETF (VUSB), Vanguard Short Duration Bond ETF (VSDB), and an active short-dated municipal bond fund, Vanguard Short Duration Tax-Exempt Bond ETF (VSDM).

With this framework and these ETFs, advisors can help manage the cash drag in their clients’ portfolios and increase the efficiency of their liquidity positions.

Vanguard bond ETFs to help increase efficiency of liquidity positions
 

Source: Vanguard, as of May 31, 2025.

Notes

1  Yields on Vanguard ETFs, Vanguard 0-3 Month Treasury Bill ETF (VBIL) and Vanguard Ultra-Short Treasury ETF (VGUS) are from Vanguard as April 30, 2025; savings and CD rates are from the Federal Deposit Insurance Corp. (FDIC) as of May 19, 2025; money market rates from the Securities and Exchange Commission as of April 30, 2025; T-bill rates from Federal Reserve Bank of St. Louis as of April 30, 2025.

2  Also, bank savings accounts are FDIC-insured up to $250,000, and money market funds are insured as securities by SIPC up to certain limits.  

3  Vanguard analysis, asset-weighted industry expense ratio of money market funds using Morningstar data, as of May 31, 2025.

For more information about Vanguard funds or Vanguard ETFs, visit advisors.vanguard.com or call 800-997-2798 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

All investing is subject to risk, which may result in loss of principal. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Investments in bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.

U.S. government backing of Treasury or agency securities applies only to the underlying securities and does not prevent share-price fluctuations. Unlike stocks and bonds, U.S. Treasury bills are guaranteed as to the timely payment of principal and interest.

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