In our March issue, we reported (subscriber's link) on new money-fund regulations advanced by the U.S. Securities and Exchange Commission.
Those regs took effect last week, and Marketwatch's Chuck Jaffe (right) says they're likely to make money-market funds — already scraping bottom on yields — even more unattractive to savers who are seeking yield as well as safety.
Under the new rules...money funds must hold more liquid assets and limit their investments to only the highest-quality securities. In addition, they must reduce the average maturity of the securities they hold.
Furthermore, retail or taxable money-market funds must now hold at least 10% of assets in cash or highly liquid securities — think Treasurys — that can be converted to cash within one day. At least 30% of a money fund's assets must be in cash or Treasurys that mature in 60 days or less, or that can be converted into cash within a week....
The top-yielding money market funds currently are generating almost nothing for shareholders, with the best individual money funds paying out less than 0.2% and the top tax-exempt funds generating about 0.25%, according to Crane Data, which tracks the money-fund business. If anything, the new rules will drive those rates even closer to zero....
[Meanwhile, t]he top-yielding bank savings accounts and interest-bearing checking accounts carry annual percentage rates four or five times higher, according to BankRate.com.
That may not seem like much difference, but every little bit counts. An investor with $100,000 in cash to park will earn about $3.50 per day in an online savings account paying 1.3%, but will earn just 35 cents per day on a money fund paying 0.13%. The returns are miserable in both cases, but the extra $1,150 — and the plus of having Federal Deposit Insurance Corp. protection — is worth leaving the money fund.
Jaffe concedes that the day may come when "the new safety measures...pay off and protect shareholders." But right now, by mandating a reduction in risk, the regulations will make it even more difficult for MMFs to climb out of the low-yield hole.
To learn more about various options for savers, visit SMI's Savings Accounts page.
It's no secret that interest rates for money market funds are scraping bottom. Even the top recommendation in our current money rates table (subscription required) is paying a scant 0.30%. Vanguard Prime, one of the best-known and most popular MMFs available, is yielding a barely noticeable 0.05%.
So is it time to abandon the money-fund ship and move your savings elsewhere?
Russel Kinnel, editor of Morningstar's FundInvestor newsletter (and director of the company's mutual fund research), is advising MMF investors to hang on rather than bailing on MMFs and moving to short-term or ultrashort bond funds.
We're still wary of ultrashort funds [following the implosion of several such funds in 2007 and 2008]. Short-term bond funds can work if some losses in the short run are acceptable — for example, if you are parking money between investments, plan to hold for a year or two, or just want a conservative bond holding in your long-term asset-allocation scheme....
But for other uses, such as emergencies or upcoming big-ticket expenditures, I'd stay with money market funds. Think about what will happen when interest rates start to rise. Bond funds will initially lose money because their superlow-yielding bonds will be discounted in the face of new higher-paying bonds. On the other hand, money market funds will quickly start to have higher yields, yet they won't lose money when rates go back up.
Kinnel concedes that MMFs aren't exciting, "but money market funds are there to serve in an emergency. Insurance always costs you money, and that's how I'd look at money markets."
Another practical matter is simply: Is it worth the trouble to switch? A Los Angeles Times story (titled, "Look, Ma, Nearly No Yield") quotes Peter Crane, head of money-fund research firm Crane Data: "My general rule is, if you're not going to make $100 more [in interest] by switching, don't bother."
Although 2009 was the toughest year on record for money funds, the MMFs recommended by SMI outperformed the overall field (for the 12th year in a row). Details are available for SMI web members in our February Level 2 article.
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