2006 — Another Good Year for SMI's Money Fund Recommendations
The annual performance numbers for money market funds are now in. They don't command the same degree of investor interest as stock funds, but they teach lessons worth knowing for savers:
• Money funds that invest primarily in high quality corporate IOUs and bank CDs returned 4.53% last year, up significantly from 2.68% in 2005. The average return from the comparable money funds recommended in SMI was 4.87% (see table). Lesson: You can do better than "average" if you shop around, starting with our recommended funds.
• Larger funds enjoy economies of scale that help them generate higher returns. The average yield of the ten biggest prime money funds available to individual investors was 4.59% (as reported in the Wall Street Journal). This was slightly above the norm among all such money funds, and not quite as high as the money funds we recommended. Lesson: Bigger is not always better.
• Pioneer's Cash Reserves Fund has been on the Wall Street Journal list of worst money fund performers for seven of the past eight years. In 2006, it returned just 3.20%, 1.67% less than the average SMI-recommended money fund. Lesson: Such poor returns reflect high administrative fees—don't hold on to such losers expecting to do better next year. (What are those Pioneer investors thinking, anyway?)
• Money funds that specialize in U.S. government-backed securities returned 4.49% on average. You receive a somewhat lower return when you step up in quality, but the sacrifice hasn't been that great in recent years—a mere 0.14% in 2006 between our average recommended funds in the two groups. Lesson: The fact that it's not a more sizable reduction tells you that the difference in quality between "regular" and "government" money funds is not very significant.
• Money funds that invest only in tax-exempt state and city municipal bonds yielded just 2.92% on average. For savers in the 25% federal income tax bracket, that's the equivalent of a 3.89% pre-tax return in a fully-taxable fund (2.92 divided by [1 minus .25]). Sometimes you can get a better net return by choosing tax-frees over regular funds, but that wasn't the case last year.
• As is typically the case, bank money market accounts yielded less than money funds. In 2006, the average bank-sponsored money market account returned around 3.25%. Lesson: The convenience of banking locally comes at a cost.
What does 2007 have in store for savers? Peter Crane, managing editor of Crane Data, a leader in tracking the money fund industry, says: "With cash at 5%, 2007 looks to be the year of the procrastinator. With yields like these, what's the rush? But whether rates rise or fall (which the consensus opinion is leaning towards), cash will be extremely attractive." 
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