Money Market Mutual Funds—No Longer a Great Deal

Not that many years ago, before the financial crisis, when a client came to me with large amounts of money they wanted to keep safe, I would typically recommend a money market mutual fund. The reasons were simple: they were very secure and paid more in interest than most banks did. You could even get check writing on them, and some came in tax-free versions.

That was then, this is now. If you look at what money market mutual funds are paying in interest, it is rather poor:  around 0.01%. That’s one-hundredth of one percent. That’s $1 for every $10,000 you invest, per year. Heck, the popcorn my bank gives away on Fridays is worth more than that.

Why is this? Why did an investment vehicle that used to be an excellent substitution for a savings account suddenly and dramatically start underperforming? Simple: the Federal Reserve is doing everything it can to keep interest rates low. That affects almost all short-term income investments-- exactly where money market mutual funds invest.

Why didn’t bank accounts follow money market mutual funds down? Well, they did—to a point. After all, it’s not like banks are paying all that much on savings accounts, let alone checking accounts. But while money market mutual funds invest your money in, and share the income from, short-term bonds and other investments, banks take your money and make loans with it. Consumer and business loans pay a lot more than bonds do, even after they take out defaults, expenses, and a decent profit.

So if you moved money into a money market mutual fund in the past because it paid better than your bank, you might want to check again. Go online or call up the fund and ask them what their annualized interest rate looks like right now. Do the same thing with your bank’s savings account. Does the money market mutual fund still pay better?

If not, should you move the money? I lean toward “yes”, but you’ll have to investigate the facts as they relate to your specific situation. Also, you shouldn’t put too much hope in money market fund rates going up in the near future.  There are a number of proposals aimed at making money market mutual funds even safer than they were before the crisis. These proposals will likely keep them earning way lower than before, and they may make their daily value fluctuate. (In the past, every dollar put into a money market mutual fund stayed at a dollar, plus interest.)

Of course, your bank savings return may be just as lousy as your money market fund, though most savings accounts are paying quite a bit more. But moving money can be a bit of a hassle. And since “quite a bit more” may only equal 0.10%, moving $10,000 might raise your annual interest from that measly $1 per year to a whopping $10 per year. That might not be a big enough difference to make it worth your while.

Still, it’s worth looking into, even if you decide to do nothing. I much prefer inaction due to knowledge than stagnation due to ignorance.

This article was published in the Wichita Falls Times Record News on August 21, 2011.