A rate rebound for cash investors

Money-market mutual funds finally may be making a comeback. Last month, average annual yields on money funds moved above 1 percent for the first time in more than a year. That may not seem like much but, over the next several months, money funds could become even more attractive to investors looking for short-term places to keep cash.

The main reason for this trend is the Federal Reserve Board, which has raised short-term interest rates twice since early August. Money-fund yields follow the Fed pretty closely, but with the Fed's benchmark rate at just 1.75 percent, people shouldn't expect a quick return to the environment of four years ago when money funds yielded more than 5 percent, experts say.

Still, "the Federal Reserve's efforts to raise short-term interest rates could have a bigger impact on short-term funds and money funds than on longer-term funds at this point," says Scott Berry, a senior fund analyst at Morningstar Inc., in Chicago.

Following a series of rate hikes in 1999 and 2000, Mr. Berry notes, money-fund yields jumped more than one percentage point.

Alternative: ultrashort bonds

Investors willing to accept some price movement to get slightly higher yields also might consider "ultrashort-term" bond funds. Unlike money funds, where prices are fixed at $1 a share, prices of ultrashort-term funds can go down as well as up. But the range of price fluctuation is narrow, since the average maturity of bonds in these funds is less than two years.

Prices of bond funds with short maturities won't fall as much as those with longer maturities when interest rates go up.

Over the 12 months ended Sept. 30, for example, the price of Fidelity's Ultra-Short Bond Fund ranged from $10.03 to $10.08 a share. The fund's 30-day yield stood at 1.75 percent at the end of September.

Ultrashort funds are "a good option, particularly if you're looking for sort of an emergency savings account that you may not need to tap for a year, if ever, but you want to keep it relatively liquid and safe," Mr. Berry says, "There will be some principal fluctuation and you could lose money over a short period of time, but in general they give you a little more opportunity than a money-market fund, without a lot more risk."

For money that might be needed in less than six to 12 months, Berry believes people should stick with money-market funds.

"About a one-year to 18-month time frame is probably best" for ultrashort-term funds, adds Jay Mastilak, a senior financial consultant at PNC Bank in Pittsburgh.

With yields on both money-market funds and ultrashort-term bond funds less than 2 percent, investors need to be aware that any fees and expenses can take a big bite out of returns.

For instance, Ms. Mastilak notes, some ultrashort-term funds are sold on major stock exchanges as closed-end funds. As a result, an investor has to pay a broker's commission to execute the trades.

Don't forget fees

Meanwhile, the Securities and Exchange Commission is looking into whether some advisers are charging excessive fees on money-market funds.

Some money funds, Berry contends, are charging more in expenses than they are paying out.

For example, in a recent article on Morningstar's website, Berry pointed out that AllianceBernstein Capital Reserves was paying a yield of 0.57 percent, while the fund had expenses of 0.98 percent. At the same time, Vanguard Prime Money Market had a yield of 1.27 percent, but charged just 0.32 percent in expenses.

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