Look beyond yield when buying money
The "D" word is bad news for money market
funds. Federal Reserve chairman Alan Greenspan says the risk of
deflation is somewhat remote but bears close watching. That could
mean trying to head it off by cutting short-term interest rates
at the next Federal Reserve Open Market Committee meeting.
A cut would cause money
market funds, which are primarily composed of short-term securities,
to drop their yields even further.
As yields decline there is always the danger that a fund's expenses,
which are typically taken out of the yield, will devour it and result
in what's called a negative yield.
Average money market fund
The average seven-day yield on taxable money market
funds is 0.70 percent after expenses, according to IMoneyNet. The
average expense ratio is 0.60 percent.
"Sixty percent of money market fund companies
are waiving a portion of their management fee, up from 58 percent
a year ago," according to Peter Crane, vice president and managing
editor at IMoneyNet.
"There are many that have a permanent waiver.
They've been subsidizing some expenses, so it's tough to tell whether
they're waiving or not. Some never intend to recoup the costs."
Money market funds are not federally insured, but
they are regulated as to the quality, maturity and diversity of
the securities in which they invest. Among the most common investments
are short-term government securities and high-quality corporate
debt. The goal is to maintain a $1 share price while trading securities
to get the highest yield.
If the share price drops below $1, it's called "breaking
the buck." This could happen if the fund's securities lose
money. To date, only one money market fund has broken the buck;
the fund was then liquidated. Breaking the buck is different than
a negative yield caused by high expenses. But the result could be
the same: Investors could lose principal.
Look for low-cost money market funds
The risk of losing money in a money fund may be remote, but
consumers can avoid funds that walk closer to the danger line, and
they can earn a higher return by looking for funds with very low
expenses and top quality investments. Chasing money market funds
with the highest yield isn't always a wise move.
"Most people see money market funds as a convenience,"
says Gary Arne, managing director of funds research at Standard
& Poor's. "They don't think too much about it. The more
knowledgeable look closer: What are the fees? What does the fund
Morningstar analyst Scott Berry says the expense ratio
is more important than the yield.
"The cheaper the fund, the more yield it can
typically offer. A 1 percent expense ratio is at the high end. Vanguard's
Prime Money Market Fund has a 0.33 percent expense ratio and yields
about 0.90 percent. Another fund may have a 1 percent expense ratio
and yield 0.30 percent.
"Also look at whether a fund is waiving a portion
of its expenses as yields have come down. People should realize
that the fund company may not do that forever. Look at their Web
site or talk to a broker. There should be some kind of flag that
points to a footnote saying a portion of the fee has been waived,"
Safety and quality ratings
Experts also advise looking for money market funds that hold
securities with the highest credit ratings such as U.S. Treasuries
or AAA rated corporate debt.
"Try to maintain short-dated securities that
mature in 13 months or less," says S& P's Arne. "We
limit the amount of floating rate securities they can buy. They
have to keep 60 days average maturity for our highest rating."
S&P rates money market funds on the basis of credit
quality and safety; fees are not taken into consideration.
As low as yields are, millions of people have opted
to cut their stock market losses by stashing cash in money funds.
"People look at a nominal yield of 0.70 percent
and say this stinks, but you have to pay attention to the alternatives,"
"If other investments are going down by 10 percent,
0.70 percent doesn't look so bad."
John Bacci, financial planner with Foundation Financial
Advisors in Linthicum, Md., uses money market funds as "no
lose" accounts for clients who are fed up with the stock market.
Even with inflation and taxes further eroding the minuscule return,
Bacci says he prefers money market funds to the alternatives.
"Conservative investors are probably in the worst
place right now. It's sickening how low yields have gotten. If you
use a high-minimum-balance fund you can get them up around 1 percent,
but you're just buying time until the equities recover. It's not
so much of an investment choice as an investment of last resort.
"It keeps the client invested, otherwise people
would stop investing altogether. We keep them in stocks for the
long-term portion of their account and then we compromise. We take
their new money and put it in a short-term account where it won't
Investors are learning to pay more attention to fees
during this time of super-low yields. But experts point out that
fees are just as important when yields are 6 percent as when they're
below 1 percent. Fees, taxes, and inflation eat away at your total
return; fees are the one element you have some control over.