Last week’s quarter-point cut in short-term interest rates made a bad situation worse. Within a month or six weeks, the average taxable money fund may be paying just 0.45 percent, down from an already miserable 0.64 percent today, says Peter Crane, vice president of iMoneyNet, which tracks the industry’s performance. Tax-free money funds, now at 0.55 percent, may drop to 0.4 percent. Time to take a hike.
A few funds still manage to pay more than 1 percent. These include PayPal Money Market Fund (on the Web), Bunker Hill, Invesco Treasurer’s Money Market Reserve, McMorgan Principal Preservation and Alpine Municipal. Says Crane: the key difference is fees. (For top-paying funds, see imoneynet.com.)
It may surprise you to learn that low rates endanger some money funds, too. Their ironclad promise to investors is that you can’t lose. If you put a dollar in, you’ll always get a dollar out, plus the accumulated interest. But the low rates the funds are earning on their investments today aren’t always enough to cover their fees and pay you, too. If they don’t pay, your dollar could drop to 99 cents or less–a calamity the industry calls “breaking the buck.”
That buck “is the most sacred aspect of money funds,” says Bruce Bent II, head of the Reserve Funds in New York City. Investors–especially institutions–don’t necessarily care how much the fund yields. But they do want instant access to their money, plus the assurance that it’s safe. If a fund were to break the buck, money might flee.
Funds sold by commissioned brokers are the closest to breaking the buck, says Morningstar analyst Rachel Barnard. To stop that from happening, some 3 percent of all money funds will be waiving part or all of their fees, Crane says. In the worst case, the fund sponsors would use their own capital to get you paid.
But why worry? Savers seeking safety and better yields, too, have a couple of other choices. For example, a bank. Banks today are paying an average of 1.4 percent on their government-insured money-market deposit accounts. Those rates, too, will probably drop after last week’s cut, but they’re better than the pittance the money funds have on offer. For high-yielding bank money-market accounts, check the listings at bankrate.com.
The best rates come from Web banks, such as Bank of Internet USA (2.35 percent), VirtualBank (2.2 percent) and NetBank (2.08 percent). But even community banks are paying more than money funds do. “Right now, our major competition is other banks,” says Matthew Walter, senior vice president of the Palmetto Bank in Laurens, S.C. The high rates are worth it, to hold on to deposits, says Randy Rouse, senior vice president at Broadway National Bank in San Antonio, Texas. But they probably won’t last.
And here’s a thought for people with a 401(k). See if it offers a stable-value fund. These funds, like money funds, promise that you’ll always get your principal back plus whatever interest you earn. The guarantee is purchased from an insurance company or bank. Interest rates currently average about 5 percent, says Gina Mitchell, president of the Stable Value Investment Association. But note that rates can be changed every quarter or even every month. Yields on stable value funds tend to lag the market, Mitchell says, so when rates turn up again, your investment may not look as juicy as it does now.
You can also get stable-value funds for IRAs. The companies offering them include Scudder, Security Capital, Vantagepoint, Gartmore Morley, PBHG, Principal Investors and Oppenheimer. There are usually minimum holding periods (say, 12 months) and redemption fees if you sell when rates are going up. The Securities and Exchange Commission is currently checking the accounting at stable-value IRAs to see if the valuations are fair.
Planner Denise Leish of Money Plans in Bethesda, Md., adds U.S. savings bonds to the safety list. Right now, inflation-adjusted bonds are paying 4.66 percent (rates change twice a year). You have to hold for at least 12 months before cashing in.
Some other investments yielding more than money-market funds include short-term bond funds, Ginnie Mae funds, high-yield bond funds and dividend-paying stocks. But with these, you take on investment risk. Nothing is actually “safe.”
One investment to beware of: the “principal protection” funds. They invest your money in bonds and a modest amount of stocks, and guarantee no loss, before fees. But the fees are super high–in the area of 2.25 percent to 2.95 percent annually, says Kristin Adamonis at Financial Research Corp. in Boston. And you have to hold for five or seven years. If you withdraw early, you’ll lose your guarantee and pay a fee, besides. Not all protection is worth paying for.
