The search for something in lieu of a money fund
After you've gotten 16 percent interest from a money market fund, can anything else make you quite as happy?
Many people are asking that question these days as they watch the returns on their money fund accounts drop to 10 percent or lower. Whereas once investors in money funds earned three times as much as in ordinary passbook accounts, now they have to be satisfied with not even twice as much. So they are looking for alternatives to money funds where they can get high interest again.
In a way, lower money fund returns are not all bad. They are a reflection of lower interest rates throughout the economy, including home mortgages, something most people have been wanting for some time. And with inflation also down in the 5 percent range, the real return - the money fund rate minus inflation - is about the same as it was a year ago.
This high real return may partly explain why money fund assets have remained strong despite declining rates. The almost vertical growth rates of the funds in the past two years have slowed in recent weeks, but their total assets have remained high. Part of the reason for this, analysts believe, is that many shareholders are keeping their money in the funds while they figure out a long-term investment strategy.
Also, tax-free money funds are still attractive to many investors in middle- and upper-income brackets. With 6 to 7 percent interest rates, these returns translate into the equivalent of 12 to 14 percent for someone in the 50 percent bracket.
Finding an investment with the two main advantages enjoyed by money funds - liquidity and yield - will be hard, says Barbara Lee, a broker with Shearson/American Express and author of a new book on investing, ''The Woman's Guide to the Stock Market'' (Harmony Books, New York, $11.95). ''There's nothing with exactly the same combination of liquidity and interest that the money funds have,'' Ms. Lee says. With money funds, you have complete liquidity, the ability to make withdrawals by check or phone anytime you like. You also have near-market interest rates.
For many people, an investment in a money market fund is the first time they've put their savings into anything besides the bank or a sock in the dresser drawer. So they are cautious about anything new, like stocks and bonds.
Here are some possible alternatives to money funds proposed by several mutual fund companies.
The Vanguard Group, a mutual fund company based in Valley Forge, Pa., plans to introduce in November a fund made up of short and medium-term debt issues. These would include, said William Hostler, Vanguard's marketing director, US Treasury and agency bonds, corporate bonds rated A or better, certificates of deposit from major banks, and prime commercial paper. The average maturity on the fund will be about four years, compared with seven years for most funds of this type, and the yield should be better than money market funds, with the same liquidity privileges, although there may be some risk of fluctuations in share prices.
''If investors are willing to give up some liquidity in exchange for interest ,'' said Donald St. Dennis, spokesman for Investors Diversified Services, a Minneapolis mutual fund company, ''they may be interested in a bond fund.'' These funds are offered by most major fund companies and are currently paying rates of 12 to 14 percent.
There is some risk, however, in that the prices per share of stock and bond funds fluctuate, while the share prices of a money market fund remains constant at one dollar. So if you make a withdrawal from a stock fund, for instance, you may be redeeming more shares to get that money than the dollars bought in the first place.
Families should keep some assets in a quickly available, liquid form, however , like a money fund or some other type of savings vehicle. You still need an account you can get to quickly, where the principal is reasonably safe, and where higher than offered in passbook savings accounts. Most experts do not think money fund rates will go much under 9 percent, and almost certainly not below 8 percent.
Next week, we'll discuss some alternatives to money funds that can be found outside the mutual fund industry.
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