Over the past year, interest rates have
caused significant fluctuations in the
stock and bond markets, resulting in
considerable losses for investors.
However, this rise in interest rates has
turned out to be a massive advantage for
money-market funds, which were
previously an overlooked investment
option used to park spare cash
temporarily while waiting for
deployment in more profitable ventures.
Today, money-market funds have
become the go-to destination for safe
investments that offer investors yearly
yields in the vicinity of 4% to 5%. This is a
significant improvement compared to
bank savings accounts, which usually
offer rates well below 1%.
Money-market funds are primarily
sponsored by financial giants like
Fidelity Investments and Charles
Schwab and invest in low-risk, short-
term debt. Unlike stock and bond funds,
they do not appreciate in value, but they
provide peace of mind and decent
yields.
The sudden surge in money-market
funds is remarkable. For years, they had
to contend with microscopic rates.
However, the Federal Reserve began to
increase rates in March 2022 to combat
inflation, and investment inflows into
the funds started to pick up. This spring,
money-market funds became a refuge
destination, with investors seeking
sanctuary after the failure of Silicon
Valley Bank and Signature Bank and the
resulting turbulence in the regional
banking sector.
According to the Investment Company
Institute, US money funds reached a
record $5.25 trillion as of April 5. Brian
Frank, Chief Investment Officer of Frank
Capital Partners in Key Biscayne,
Florida, says, "There’s an avalanche of
money going out of banks and into
money-market funds. You get 4% or
more of relatively risk-free yields.”
Moreover, interest rates are expected to
increase even more. Judith Raneri, a
money-fund portfolio manager at
Gabelli Funds in Rye, New York, says,
"Going forward with the ongoing risk of
inflation, a strong housing market, and
future policy changes by the Fed,
interest rates are expected to move
higher." Although the Fed is expected to
be nearing the end of its hiking regimen,
interest rates are likely to stay at their
current level for some time, providing
continued attractive returns for fund
holders.
Anatomy of a haven investment:
Money-market funds have become an
increasingly popular investment option
for those seeking safety and yield,
particularly as interest rates have risen
over the past year. While stocks and
bonds have struggled in this
environment, money-market funds have
experienced a surge in inflows, with
assets reaching a record $5.25 trillion as
of April 5, 2023.
These funds invest in short-term, low-
risk debt securities such as Treasuries
and investment-grade-rated debt
obligations. They offer yields of around
4% to 5% per year, compared to bank
savings accounts which typically offer
less than 1%. Many funds also allow
investors to write checks and make
withdrawals without penalty, making
them a convenient alternative to
traditional bank accounts.
One potential downside of money-
market funds is that they do not offer
the same level of government-backed
deposit insurance as banks. However,
their highly liquid and stable holdings,
as well as their commitment to
maintaining a constant net asset value of
$1 per share, make them a relatively safe
investment choice.
It is important to note that some banks
also offer money-market accounts,
which are often confused with money-
market mutual funds. However, these
accounts generally offer lower yields
than money funds, and do not benefit
from the same level of stability and
liquidity.
While money-market funds have
generally been a stable investment, there
are potential risks to consider. For
example, in the event that Congress fails
to raise the debt ceiling, there is a risk of
default on Treasuries which could lead
to a decline in their prices. Additionally,
the 2008 financial crisis saw the Reserve
Primary Fund, the original money fund,
"break the buck" as its NAV fell below $1
per share. However, the U.S. Treasury
Department stepped in to guarantee the
fund's share price, suggesting that the
government is willing to provide
support in times of crisis.
Which money-market funds yield the most?
When considering money-market
offerings, investors want to know which
ones provide the highest returns. There
are four main types of money-market
funds: Treasury funds, government
funds, municipal funds, and prime
funds. Treasury funds invest in U.S.
Treasury bonds, government funds
invest in Treasuries, government-
sponsored enterprise bonds like Fannie
Mae, and overnight repurchase
agreements for government securities,
municipal funds invest in tax-exempt
bonds from local and state governments,
and prime funds invest in short-term
corporate debt, such as commercial
paper, along with some non-Treasury
government bonds.
Unlike actively managed stock funds,
money funds don't require large teams
of analysts to search for good buys,
which means they don't carry heavy
expenses. In 2022, the expense ratio for
money funds was only 0.13%, a fraction
of stock funds and a third of bond funds.
Furthermore, money funds yield returns
that are between what stock and bond
funds provide. On average, money
funds yield 4.7% compared to the S&P
500's total return of 7.2% and the
Bloomberg Agg bond index's 3.4% for
the year. According to Will Stark,
Managing Director of Private Wealth
Services at Howard Capital Management
in New York City, "They're competitive,
with low expenses."
In terms of yield, money fund categories
are relatively similar, but they offer
different portfolios with varying risk
profiles. According to Crane Data, prime
funds have the highest average yield, at
4.7%. This makes sense because
commercial paper, while not too far out
on the risk curve, lacks the assurance
that Treasury bonds provide.
Government and Treasury funds, which
fall squarely in the federal camp, are
perceived to have lower risk. Their
average yields are 4.25% and 4.23%,
respectively. Municipal debt funds, or
munis, are tax-exempt, which allows
them to pay less than the other funds,
averaging 3.59%. However, investors
benefit from tax avoidance. For
someone in the 32% tax bracket, this
translates to what's known as a tax-
equivalent yield of 5.3%, at the high end
of the money fund yield scale.
While Crane doesn't break out
individual municipal high-yielders,
Fidelity Municipal Money Market
(FTEXX) is a well-known standout,
according to Howard's Stark. Its yield is
3.8%, or a tax-equivalent yield of 5.6%.
For the top-yielding government money
fund, Vanguard Federal Money Market
(VMFXX) is on Crane's list at 4.75%. For
Treasury funds, Vanguard Treasury
Money Market (VUSXX) is on top at
4.7%. JPMorgan Liquid Assets Money
Market (CJLXX), sponsored by the
bank's asset management arm, leads the
prime funds category with a yield of
4.98%.
Inflation is an enemy of interest-paying
investments, as it eats away at income,
but inflation appears to be declining.
The Fed's preferred inflation gauge, the
most recent personal consumption
expenditures price index, rose 5% from a
year earlier, down from 5.3% the
previous month. This is not far off from
what money funds are currently paying.
If the long-predicted recession does
finally arrive, stocks will decline, and
those with substantial money fund
accounts can purchase shares cheaply. In
the meantime, investors in money funds
are being paid decently.
This story was originally featured
on Fortune.com
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