Skittish about stocks? Then join the parade of small investors – and quite a few big-time institutions as well – who are rediscovering the virtues of money-market mutual funds.
After a long stretch of paltry returns, money-market funds are regaining their luster as attractive cash alternatives. Taxable money-fund yields have climbed steadily this year and now average close to 4.6 percent, their best levels since 2001. Rates are likely to head even higher, as the Federal Reserve's anti-inflation campaign continues to lift short-term interest rates, notes Connie Bugbee, managing editor of iMoneyNet, a money fund ranking firm.
Money fund yields could well reach the eye-catching 5 percent level before year-end, she says, if the Fed were to boost its benchmark fed funds rate, now at 5.25 percent, another notch this fall. The highest taxable money fund yield in a recent survey by iMoneyNet was 4.97 percent. That's a plumper return than the typical stock fund has earned so far this year and with far less risk.
Moreover, that payout is a cut above the 4.2 percent rise in the consumer price index over the past 12 months – so money-market funds are outpacing inflation.
Money funds hold short-term, high-quality debt securities, such as commercial paper issued by corporations, bank certificates of deposit, and US Treasury bills. By law, money funds must maintain an average maturity on their securities of no more than 90 days. That protects the portfolios from interest rate gyrations and enables them to maintain a constant share price of $1.
Money fund yields now compare favorably with what many banks pay on three- and six-month certificates of deposit (CDs), according to Greg McBride, senior analyst at Bankrate.com.
"With a money fund," Mr. McBride says, "you're not being penalized for giving up some liquidity, as you must do with CDs," he says.
With a bank CD, any premature redemption reduces the amount of interest paid. Money-market funds, most of which offer check-writing privileges, provide ready liquidity. Many banks have been reluctant to boost CD payouts because that would squeeze profit margins on mortgages and other types of longer-term loans.
Investors often park idle cash in brokerage accounts into interest-earning options. More often than not, the cash is automatically rolled into a brokerage-affiliated bank deposit account. These deposits are insured up to $100,000 for each individual by the Federal Deposit Insurance Corp., providing a level of security that money-market funds don't.
Many investors aren't aware, however, that they may opt to have cash put in a money-market fund, which typically yields considerably more than the default bank option. For clients with $10,000 or less to invest, Charles Schwab, for example, sweeps cash into a bank deposit account that yields about 1 percent. Schwab's Government Money Market fund, by contrast, pays 4.3 percent. But Schwab clients must specifically request the money-market fund option.
Since brokers' bank deposit accounts are not competitive with money-market mutual funds, they shouldn't be used as long-term savings vehicles, says Ms. Bugbee. "Brokers have no obligation to pay a competitive rate on sweep options." she says. "It's up to the investor to select the best options."