Safety a key element of money market deposit accounts
Boston — When money fund expert William E. Donoghue put the words safety, liquidity, and yield together several years ago, he called it the SLY system. He was just talking about money market mutual funds at the time, but today the term applies just as well to the money market deposit accounts available at banks and savings-and-loans.
People looking for a place to park their savings where they can be assured of the principal's remaining intact, where they can get to their money quickly without penalties for early withdrawal of funds, and where they can keep close watch on the interest rates and compare the competition on a weekly basis probably cannot beat the money market funds or the banks' money market deposit accounts (MMDAs).
This does not apply to the Super-NOW accounts that banks and S&Ls also offer; because of high reserve requirements that force banks to keep a small portion of the deposits in a noninterest-earning account and unlimited checking privileges, the Super NOWs do not offer as high a yield as the money market accounts. Unless you need a checking account containing thousands of dollars, pass this one up.
Like any competing products, there are advantages and disadvantages to both money funds and the MMDAs.
For savers, the most important criterion is safety. Based on their past performance and the regulations they work under, money market funds can be considered just as safe as the MMDAs. Of some 300 money funds, only one has ever failed, and in that case investors got back 93 cents on the dollar. Since then, the industry and its regulators have adopted stiffer precautions that most analysts believe will prevent even that much of a loss. The funds investments are simply too diversified and closely monitored to cause much worry.
The MMDAs, of course, are insured by the federal government, up to $100,000 per account, so if you have more money than that, you can simply open more accounts. If you have that much money, however, you are probably looking for a higher yield and will be using neither money funds nor MMDAs, except as short-term ''parking places,'' while another investment is selected.
As for liquidity, or access to your money, both money funds and MMDAs offer no withdrawal penalties. The MMDAs, however, will pay no more than 51/2 percent on balances under $2,500. Some banks pay no interest at all on balances below this amount. And you are limited in the number of withdrawals you can make: a maximum of three checks a month and up to three other prearranged transfers in the same month. With the money funds, you can draw down your account to whatever level you like, even below the $1,000 minimum deposit most funds require.
It is in the yield, or the interest rate they pay you, that the greatest confusion and misleading information exists between money funds and MMDAs. When they were introduced on Dec. 14 last year, the MMDAs were paying several percentage points more interest than the money funds, which were experiencing the effects of the overall decline in interest rates in the economy. In some cases, the banks and S&Ls were offering substantially higher ''come on'' rates - sometimes as high as 20 percent on an annualized basis - in order to attract deposits.
It only took a few weeks, however, for the banks to begin scaling down these rates to levels they could more easily afford. And by the end of July, MMDA and money fund rates met, as the money funds rates went up faster than the MMDAs.
One reason for the merging of the rates can be found in the way the banks and mutual funds figure their interest rates. Banks and S&Ls can pay whatever rate they want or can afford. This rate can change weekly, monthly, or however often the bank officers choose to change it. Some banks ''peg'' their rate to a certain index, such as the latest three-month Treasury bill rate. Ironically, other banks' rates are pegged to the money market funds, as compiled by the Donoghue Organization.
The money market funds, on the other hand, do not really have a choice in what rate they will pay. After taking out a fraction of a percentage point for their management fees, the funds are required to pay all of the combined yield that comes from the securities in their portfolio. To be competitive, they must make sure that portfolio contains the highest-earning - as well as safe - securities.
The major advantage to the banks' MMDAs is security. If you get concerned about the safety of your savings if they are in anything but a federally-insured account, then you should stick with the banks. You may also prefer the convenience and personal service of dealing face-to-face with a person in a local bank office instead of the mail-telephone relationship used by the money funds.
If you do decide on an MMDA instead of a money fund, try to find a bank that uses an index, such as Treasury bills or the Donoghue average, to set its rate and that guarantees to stick by that index on at least a monthly basis. Some banks change their rates every week.
Many money fund customers saw the primary advantage of the flexibility of their choice in the past year or so as yields fell from over 16 percent to under 8 percent. With the stock market making historic jumps, many fund shareholders switched all or part of their money to a stock fund. If they got aboard a well-managed, aggressive equity fund, they may have made more money than they did when the money funds were at their highest levels.
One alternative for people in higher tax brackets is the tax-exempt money fund. Earlier this summer, the tax exempts were averaging 4.7 percent while the taxable funds' yields stood at 8.6 percent. For people in the 45 percent federal tax bracket, these rates provided about the same after-tax yields. But for anyone whose taxes were above 45 percent, the tax-exempts offered a distinct advantage. That 8.6 taxable rate, for instance, nets the 50-percent-bracket taxpayer only 4.3 percent.
Finally, a few states, including Massachusetts, tax the earnings on money funds at a higher rate than on those bank accounts, which may be another consideration for some people.