Rethinking the Money Market Default

Overview:

There is a near-record amount of investor cash sitting on the sidelines. The Wall Street Journal featured the topic as its lead personal finance story this week. U.S. households currently hold more than $3 trillion of money market funds, and that doesn’t include the institutional trillions parked alongside them.¹ Much of that cash arrived when money market yields exceeded 5%. Since then, the Crane 100 money market index has compressed roughly 160 basis points to 3.5%. Surprisingly, those balances have stayed put. Status quo bias is powerful since moving cash requires an active decision, and leaving it requires nothing. 

The inflation rate is the hurdle every dollar has to clear. This week’s July inflation report put year-over-year headline CPI at 3.4%, slightly cooler than June but well above the Fed's 2% target and ahead of wage growth. 

Not only has the inflation hurdle gone up, but the front-end of the curve is now upward sloping. Cash that was well positioned at the beginning of the year may not be today. Money market funds are the right home for cash that must be available on a moment's notice, but for cash planned to be used months, quarters, or years away, other vehicles may deliver higher yields. 

Diversify’s Take:

The Fed Sets the Front End

It is worth remembering that the Federal Reserve controls the overnight lending rate, and market forces determine rates beyond that. Money market funds track Fed policy closely because their holdings are extremely short-term, which means their yields are largely a Fed decision rather than a market one. Our take is that the Fed is relatively stuck for now. We anticipate zero or one 25 basis point rate hike between now and year-end. Meanwhile, the market is pricing a longer list of risks: the Iran War and the resulting energy shock, lingering tariffs, an AI buildout that is simultaneously raising component costs (“chip-flation”) while requiring new financing needs, and a federal deficit that is competing for that same capital. The rates market is now demanding

higher compensation to lend beyond overnight. That curve steepening is shown below.

Treasury Rate Comparison²

Modestly Extending May Finally Pay

In January, the curve inside one year was inverted. One month paid 3.72% while twelve months paid 3.47%, so investors were penalized 25 basis points for extending, and staying at the very front end was the rational choice. That has reversed. Twelve-month maturities now pay 4.03% vs. 3.79% for one-month, a 24 basis point premium. Because markets are forward looking, that premium already embeds roughly one rate hike. You are being paid in advance for a hike that may or may not come. Importantly, beyond the front end, we still aren’t being compensated for taking much duration risk in most bond segments. Municipal bonds are the exception. 

The Nominal Yield Is Not The Return

Money market income is ordinary income, taxed at your top marginal rate. At a 35% combined rate, 3.49% becomes roughly 2.27% in hand, a loss of about 1.1% of purchasing power annually. Given the pressures mentioned above, a rapid drop in inflation is possible but not something to count on. The goal is to beat inflation or close as much of the gap as possible without changing the risk you incur.

Fees And State Taxes Close Part Of The Gap

Money market funds commonly carry net expense ratios of 0.30% to 0.40%. Diversify's Short-Term Cash Management strategy fee is 0.15%. Treasury interest is also exempt from state and local income tax. Money market fund income is taxable except for the portion derived from government obligations, which varies by fund and, in some states, is lost entirely if the fund misses a minimum threshold. For a taxpayer in a 6% marginal state tax bracket, a six-month bill at 3.99%, net of Diversify’s fee, is worth roughly 4.09% on a taxable-equivalent basis against 3.49% for a money market fund lacking state tax exemptions. That is a 60 basis point difference, or $6,000 a year on $1 million, at a comparable risk profile.

If The Motive Is Safety, Examine What You Own 

Most large cash balances do not represent a yield comparison. Rather, they are a desire to feel secure, and that instinct deserves respect. But the feeling and the investment structure are two different things. A T-bill is a direct obligation of the U.S. government maturing on a specific date. A money market fund is a pooled vehicle holding various short-term paper. Both are conservative, but only one is owed directly to you. 

With that backdrop, here is how the two structures compare across key features: 

Investment Implications:

Move Known-Horizon Cash Into Short-Term Cash Management

For balances with a defined use of several months or more, we can build a direct ladder of individual T-bills matched to the dates the money is needed. You own the U.S. obligations rather than a pooled fund, you capture the state tax exemption, and the rate is fixed for the term. Staggered maturities mean cash comes due on a schedule, so liquidity stays intact and reinvestment happens continuously rather than all at once.

Keep True Operating Cash Where It Belongs

Emergency reserves and day-to-day liquidity should stay in a money market fund. Same-day access, sweep integration, and bill pay are worth paying for when that is actually needed. Money markets have a place. The trouble is that they are being asked to hold assets with a known horizon that does not need daily access. 

Transition Excess Cash Off The Sidelines

Balances with no defined job and no date are not short-term money. Those dollars need a goal and a time horizon before they need an allocation. Once they have both, they belong in a combination of directly held bonds where we control the credit quality and maturity, high-quality equities for the growth engine with a long horizon, and alternatives for clients who can bear the illiquidity. 

Start With An Assessment

None of the above happens without knowing what you are holding and why. Our team of professionals will run that review with you, size what genuinely needs to stay liquid, and put the rest to work on your behalf. 

Summary:

Holding cash is not the problem across American households. But holding unexamined cash may be. A money market fund is an excellent home for money that must be available today, and a poor one for money that will not be touched for several months and beyond.

The yield curve has changed in 2026. In January, there was no reward for extending, so parking at the front end made sense. Today, 12-month Treasuries pay 24 basis points more than 1-month Treasuries, and once the state tax exemption on Treasury interest is layered in, a short T-bill ladder could be worth roughly 60 basis points a year more than the average money market fund. That spread difference adds up. Meanwhile, the inflation hurdle remains, and on an after-tax basis, money market income is quietly losing purchasing power.

Every dollar in your portfolio should answer one question: what is your job? If the answer is "waiting," it needs a game plan and a time horizon. If the answer is "safety," consider a directly-held Treasury ladder, but be mindful of what feeling safe may be costing you. Please reach out to your Advisor to review your cash balances.

David Wrigley

Chief Investment Officer

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1. Source: Investment Company Institute, as of August 5, 2026

2. Source: U.S. Department of the Treasury, as of August 11, 2026. 9-month yield linearly interpolated between the published 6-month and 12-month yields  

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The information contained herein is the opinion of the author as of the date the market update was written and is subject to change without notice as markets change, and new information is available. While Diversify utilizes sources deemed to be reliable, we have not independently verified the content. Investors should carefully consider any changes based on this market commentary and discuss their individual circumstances with their trusted advisors. Past performance is not indicative of future results. This communication is for informational purposes only and should not be construed as investment advice or a recommendation.