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 Money-Market Funds: Down to Zero

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PostSubject: Money-Market Funds: Down to Zero   Fri Apr 16, 2010 7:29 pm

Thought some of you might be interested in the following:

Money-Market Funds: Down to Zero
Another chapter in the financial crisis is winding down: Not only has the government stopped backing money-market funds — a vote of confidence that the industry can stand on its own -- investors in the now-closed Primary Reserve Fund are expected to be made almost whole.

But that doesn’t mean that money-market-fund investors don’t have anything to worry about. For investors who haven’t glanced at their account statements lately, the latest problem is near-zero interest rates. While the Primary Fund announced this week that it has sold the remainder of its Lehman Brothers debt (and will come close to paying investors all of their money back), money-market-fund yields are barely a ripple in the income stream. With rates so low, several fund companies have been subsidizing fees for investors. In fact, Charles Schwab said Thursday in its first-quarter earnings report that it took a $125 million hit from that.

The average seven-day yield on individual taxable money-market funds is 0.02%, down from 0.21% a year ago, according to iMoneyNet, which tracks money-market mutual funds. The yield on individual tax-exempt money-market funds is 0.03%, down from 0.30%, a year ago. Those returns of course pale in comparison to the stock market lately. But they’re even lower than interest rates offered on some money-market bank accounts.

Why so low? Blame the Fed. Money-market fund yields are mostly determined by the Federal Reserve’s federal funds rate, and that has been at a historical low of 0% to 0.25% since December 2008 as the Fed tried to jumpstart the economy. What’s more, those yields will likely stay low until the Fed raises its rate, which many economists don’t expect to happen until later this year.

Investors are shifting their money accordingly. As of April 7, the total amount invested in individual money-market funds was $2.96 trillion, down from $3.8 trillion a year ago, according to the Investment Company Institute.
Here are some things for safety-conscious investors to consider:

Timing
Investors wondering whether to stay in a money-market fund now should consider how soon they’ll need to use the cash that’s stashed there. If the cash is meant to be used within the next few months, consider sticking with the fund, says Lee Baker, a certified financial planner and president of Apex Financial Services in Tucker, Ga. Your money is liquid there, and it’s unlikely it will be able grow much more in another type of safe investment during such a short time period.

If you don't need your cash for at least a year, consider moving it somewhere else where you can get a comparatively higher rate, he says. In this scenario, most investors will be better off waiting until the Fed raises rates and the yields on money-market funds increase before returning to them, he says.

Talk to Your Bank
Bank money-market accounts or certificates of deposit are good alternatives, says Baker. CDs are federally insured and currently provide a higher return. The average yield on a six-month CD is 0.44%, according to Bankrate.com. On a one-year CD, the average yield is 0.72%. Money-market deposit accounts are currently yielding an average 0.22%. Unlike the bank accounts, money-market funds are not guaranteed by the government. (In response to the financial crisis, the Treasury Department stepped in to guarantee money-market funds, but that was a temporary measure, which ended in September 2009.)

The Liquidity Factor
The safety and liquidity of money-market funds could improve this year. In January, the Securities and Exchange Commission amended regulations governing money-market funds, and those changes will start taking effect in May. They include liquidity standards that will require money-market funds to have larger cash reserves that can meet increased demand by investors to withdraw cash.
According to an SEC statement, that means money-market funds will have to meet both daily liquidity requirements of 10% of assets in cash and cash equivalents, and weekly liquidity requirements of 30%. The good news is, these changes could help quell the fear of a repeat “breaking the buck” scenario, when a money-market fund trades below a dollar, says Peter Crane, president of Crane Data, which tracks money-market funds. On the other hand, they could also mean that yields will drop a bit as a result.

The Tax Exempt Option
Right now, for individual investors, tax-exempt money-market funds offer the highest yields. These funds typically invest in state and municipal debt. But many states and localities have been struggling with debt, and that adds a level of risk. Tax-exempt money-market funds are often ideal for investors in the highest two tax brackets, says Crane.

(On the Street by AnnaMaria Andriotis Published April 16, 2010)

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