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Money Market Funds Worth a Look—and More

For the first time in years, money market funds are looking like a good place for advisors to park client cash. With interest rates up to 4.75 percent—and with rates expected to continue upward—yields on money market funds are almost as high as those on short-term bonds and are attractive enough to interest even less-conservative clients, say advisors and analysts. The funds are a great way to give investors easy access to cash for income or spending needs, with relatively good returns and virtually no risk to principal.

As of March 28, the average seven-day yield on taxable money market funds was 4.1 percent, up from an average of 0.5 percent in June of 2003 and 2.1 percent in March of last year, according to Money Fund Report, the most commonly used benchmark in the industry. DWS Money Market Series Premium offered the highest yield on a taxable retail money market fund as of last week, at 4.53 percent, followed by Vanguard Prime with 4.45 percent. The average seven-day yield on tax-free money market funds was 2.59 percent as of March 28.

Not surprisingly, the amount of money in money market funds is up. As of the end of March, it stood at over $2 trillion, compared to $1.85 trillion a year ago.

“It’s a good thing for financial planning,” says Morningstar senior analyst Eric Jacobson. “It makes it easier for advisors to put money in a money market that deserves to be there without clients worrying about suffering too low a return. We tend to advocate not trying to time the market. But we are at a time when high-quality, long-term choices in the bond market aren’t yielding much more than a money market fund. So new money that needs to be deployed in some kind of income vehicle—it makes sense to put it into a money market.”

Richard Moran, an advisor with Moran Kimura & Heising in Torrance, Calif., says he’s hiked his average client allocation in money market funds to 10 percent today, up from 2 percent or 3 percent a year ago. He cites two reasons for that: one, he feels more comfortable keeping clients in cash today, and two, money market funds have become an attractive substitute for short-term bonds.

“A year ago, when money market funds were paying between 1 percent and 2 percent, I felt I had to be very aggressive in repositioning that money because we didn’t want to be charging asset-management fees of 1 percent if they’re earning that little,” says Moran. Rather than stay in cash, he aggressively invested in equities for the long term, he says. “Now the difference for my clients is we’ve been fine with letting cash build up a little bit through money market funds,” he says. “We’re sweeping dividends and capital gains distributions into them.”

Meanwhile short-term bonds no longer offer much yield advantage over money markets. And no matter how short the maturity on a short-term bond, a money market fund will always be more liquid, something that’s especially valuable at a time when interest rates are expected to keep going up or level off. Federal Reserve Chairman Ben Bernanke raised the benchmark federal funds rate a quarter point, to 4.75 percent, on March 28, and is widely expected to raise rates another quarter point in May or June.

Whereas Vanguard’s Prime money market fund is currently yielding 4.45 percent, with a minimum investment of just $3,000, the three-month treasury is at 4.67 percent. “Yes, you can pick up a little bit of extra yield,” says Morningstar’s Jacobson. “But is it really worth all that risk? Why not sacrifice the 15 to 20 basis points, if only for the safety of money market funds? If rates do continue to rise, you’re better off in money market fund for next six months to a year.”

That said, Jacobson emphasizes the importance of using low-fee choices like Vanguard, which charges a management fee of 0.30 percent, and Fidelity, which charges 0.42 percent. (IMoneyNet lists money market funds with the highest yields, net of fees, in various categories on a weekly basis.) It’s also important to keep an eye on the Federal Reserve, because eventually they could start cutting rates. “But, tactically speaking, money markets make a lot of sense right now,” he adds.

A money market fund is essentially a mutual fund that invests in highly liquid short-term debt securities issued by the government, banks and large corporations. Returns are not guaranteed, but risk is very low because the securities that make up their portfolios are virtually as safe as cash.

“I would think a financial advisor would most always have a cash portion for any of their clients,” says Connie Bugbee, managing editor for iMoneyNet. “And for that, I would think a money market mutual fund would be an ideal parking place, particularly because it’s so liquid. A CD has a term to it and a money market account only allows six transactions a month. I would imagine it would depend on the cash needs of the individual.”

A couple of financial advisors say money market accounts are particularly good for clients who are interested in buying real estate but are holding out for a softer market. “We have a lot of clients thinking about buying property—they’ve been waiting,” says Louis Barajas, a financial advisor with Louis Barajas & Associates in Santa Fe Springs, Calif., who caters to middle-income Hispanic clients with an average of $100,000 to $150,000 in assets. “We’ve seen home values stay stable and come down now for the first time in a long time. Some people had money in equity funds, and I said why don’t we move that to the money market side so you’re ready to cut a check.”

Not everyone is jumping on the money market fund wagon. Lane Jones, chief operating officer of Evensky & Katz, in Coral Gables, Fla., says he hasn’t changed his allocation. He tends to maintain a fixed allocation of 2 percent to cash for clients, which either goes to short-term bonds or money market funds, depending on the cash needs of the client. For larger balances, the firm uses a “sort of a turbo money market,” like Schwab’s Value Advantage and Fidelity’s Cash Reserves, which tend to yield 25 basis points more than the average money market fund. “We not trying to time the rate cycle,” he says.

Mari Adam, financial advisor with Adam Financial Associates in Boca Raton, Fla., says she prefers CDs to money market funds, but she is allocating more to cash. “Cash is more attractive than it was two years ago. Two years ago, we would have said, ‘Oh my god, get it out of there’,” she says. “The last time we really looked at CDs, or short-term money instruments, was probably in the early 1990s, when rates were about 8 percent. Where we have actively made a decision to use more in this asset class is in the fixed-income area. If I have a choice to buy an individual bond, or bond fund, we are now looking at short-term CDs—six to 18 months.”

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