The Mechanics Behind an Offer to Earn 5% on Cash

Open a brokerage cash page and you can easily find three different numbers all presenting themselves as roughly 5%. One sits next to a money market fund. One is the “yield” on a bond fund with a multi-year average maturity. One is an annual percentage yield on a certificate of deposit that will not let you touch the money for a year without a penalty. A recent MarketWatch piece on bond strategies frames the goal the way most savers do — a safe 5% on cash — and that framing is the problem worth taking apart. Those three numbers are not the same product priced three ways. They are three different mechanisms, and each one charges a different fee for the privilege.

So the useful question is not where to earn 5% on cash. It is which of the three things you are being asked to give up: access to the money, certainty about the principal, or certainty about the rate itself. You can usually avoid any two of those. Avoiding all three is what a checking account is for, and checking accounts are not where this conversation starts.

One caveat before the mechanics, because the whole article depends on it: the 5% figure here is a stated framing from a secondary news summary, not a market level I am confirming as of today. Yields move daily. Treat the number as a round placeholder for “meaningfully more than a bank’s default savings rate” and verify the live figure at the source before you act on it.

💰 The three engines behind a cash yield

Yield on cash-like assets is generated in only a handful of ways, and the differences are structural rather than a matter of degree.

The first engine is short-term lending to the U.S. government. Treasury bills are sold at a discount and mature at face value; the gain is the interest. The Treasury auctions 4-, 8-, 13-, 17-, and 26-week bills on a weekly cycle and the 52-week bill roughly every four weeks, with a $100 minimum purchase through TreasuryDirect. Because the term is short, the price barely moves in response to rate changes. You get your principal back on a date you knew in advance.

The second engine is term premium and credit spread — holding longer-dated or corporate bonds and accepting that their prices move. This is where the headline yields get larger and the word “safe” starts doing work it cannot support.

The third engine is a bank or credit union paying you for a deposit it can rely on. A CD pays more than a savings account specifically because you have promised not to withdraw. FDIC insurance covers $250,000 per depositor, per insured bank, per ownership category, per the FDIC — a genuine guarantee, with a named guarantor, on the principal and accrued interest up to that limit. The guarantee covers default by the bank. It does not cover the early-withdrawal penalty you pay for changing your mind.

Step one: bills, and the reinvestment problem

A 13-week Treasury bill is about as close as a yielding instrument gets to cash. Its interest is exempt from state and local income tax, though not federal — a real advantage for a saver in a high-tax state, and one that makes a Treasury bill’s after-tax yield higher than a nominally equal bank rate for that person.

But the short maturity that removes price risk installs a different one in its place. When the bill matures, you are a buyer again at whatever rate exists on that day. If short-term rates have fallen 150 basis points in the interim, your “5% cash plan” is now a 3.5% cash plan, and nothing about the instrument protected you. This is reinvestment risk, and it is the specific cost of the safety that bills provide. A saver who needs a known income stream for five years has not solved the problem by rolling 13-week bills; they have only moved the uncertainty from the principal to the income.

Does a bond fund’s yield mean what the ticker page says? 📊

Not necessarily, and the distinction is the single most common way a cash plan goes wrong.

A fund’s distribution yield describes what it has recently paid out. The SEC yield, standardized under SEC disclosure rules, is a 30-day annualized figure net of expenses and is the closer proxy for forward income. A fund holding older, higher-coupon bonds can distribute well above what its portfolio will actually earn going forward. Neither number is a promise, because a bond fund has no maturity date at which you are made whole.

That last point is the mechanism savers underestimate. Duration measures price sensitivity to rates: a fund with an effective duration of six years will lose roughly 6% of its value for a 100-basis-point rise in the relevant yields, and gain roughly that much if they fall. Stretching from a 13-week bill to an intermediate bond fund to capture an extra point of yield means accepting a position that can drop several percent in a quarter. For money earmarked for a house deposit in eighteen months, a 6% drawdown is not volatility to be ridden out. It is the plan failing.

Laddering buys you a schedule, not a shield

A ladder — equal amounts maturing at staggered dates, say every three or six months out to five years — is the standard answer, and it is a good one, but it is routinely oversold. What a ladder does is convert one large reinvestment decision into many small ones, so that no single rate environment sets the outcome for the whole portfolio. If rates fall, only the maturing rung reinvests at the lower rate; the rest keep their original coupons. If rates rise, a rung comes due soon enough to capture it.

What a ladder does not do is produce a fixed 5% for five years. It averages. And because each rung is held to maturity, the interim price swings on the longer rungs are irrelevant — but only if you genuinely hold them. Sell a five-year rung in year two and you have taken the duration loss you believed the structure had eliminated. The ladder’s protection is entirely contingent on your not needing the money early, which is the same condition the CD imposes, stated less explicitly.

⚠️ Traps: taxes, limits, and the gap between quoted and earned

Several things sit outside the yield comparison and change the answer anyway.

• Tax location. Treasury interest escapes state and local tax; CD and corporate bond interest does not. Municipal bond interest is generally exempt from federal tax, which is why a 3.5% muni yield can beat a 5% taxable yield for a high-bracket investor and lose badly for a low-bracket one. Comparing pre-tax yields across these categories is not a comparison at all.
• Purchase limits. Savings bonds are capped — TreasuryDirect sets a $10,000 annual limit per Social Security number for electronic Series I bonds — with a 12-month lock-up and a three-month interest penalty on redemption before five years. Useful at the margin; not a vehicle for a large cash balance.
• Insurance boundaries. The FDIC’s $250,000 limit is per bank and per ownership category, so a larger balance at one institution is partly uninsured. Brokerage accounts are covered by SIPC against broker failure, not against market losses on the bonds or funds inside them. Those are different protections for different events, and conflating them is how people believe they hold a guarantee they do not have.
• Fees. An expense ratio comes straight out of yield. On a cash-like position earning a few percent, 40 basis points of fund cost is a tenth of the return — a proportion that would be noise in an equity allocation and is material here.

When the yield number stops being the deciding factor

All of the above assumes the decision is about rates. Usually it is not. The binding constraint is the date you need the money, and once you fix that date, the instrument choice mostly resolves itself: money needed within a year has no business carrying duration, and money that genuinely will not be touched for five years is being underpaid in an overnight fund.

The honest limit of this teardown is that it cannot tell you what rates will do. The mechanisms are fixed and knowable; the level is not. What would change the calculus is a sustained move in short-term policy rates relative to longer yields. If short rates fall while longer yields hold, the reinvestment risk in bills becomes the dominant cost and locking a term rate looks retrospectively cheap. If short rates stay high, the saver who extended duration to reach for an extra point will have paid for income they could have had with no price risk at all. Nobody knows which, and anyone presenting a 5% cash yield as settled is quietly assuming one of those two worlds.