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November 14, 2002
"The Sinking Yields Of Money Market Funds"
The recent drop of half a percentage point in short-term interest rates by the Federal Reserve has brought a festering problem into the open: Many money-market mutual fund yields are now falling so low that shareholders are actually starting to lose money on them.
Here is how it works: A money market mutual fund typically charges a management fee of one-half of a percentage point (50 basis points) to 1 percentage point (100 basis points), or even higher. If the money fund is buying short-term securities with yields of 2%,3% or 4%, the fund shareholder nets a decent yield -- and no one is upset. But when yields fall to the levels they are at now, with the average yield at 1.2%, money fund shareholders could, and actually are, either not earning anything or starting to lose money. With the Fed’s move, rates are clearly going to fall below 1% in coming months, meaning more and more money funds are going to "break the buck," which means return less than the shareholder put in. The "money fund buck" is considered sacrosanct in the money fund industry because no fund has ever not redeemed shares at $1 per share, so this is causing a huge amount of distress. There are two main ways that money funds can deal with the problem: lower their management fees, or go out of business. Funds are doing both. Some funds are lowering their management fees from 50 to 20 basis points, which means that shareholders still get a measly, but positive, yield. Of course, this means the fund company makes a smaller profit than it is used to. In several other cases where the fund company does not want to cut its management fees and shareholders are about to start losing money, the money funds are either being closed down or merged into other money funds. If this happens to you, be careful that you haven’t written checks on these money funds that might bounce if the fund is liquidated. So, what can you do if your money fund is now earning less than 1%, or in some cases, less than 0% after expenses? There are two steps you could take: switch to a bank money market deposit account, which doesn’t charge management fees, and might have a yield of about 1% to 1.5%; or, if you are willing to take slightly more risk, try a short-term bond fund. Short-term bond funds now yield about 4% and are available from all the major fund families, like Fidelity, Vanguard, T Rowe Price, etc. They buy bonds with maturities of about 2 years and offer a much higher yield than money funds with maturities of 90 days or less.
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