Money-Market Funds Yield Above 5%. They Still Might Not Be the Best Investment.

Owning these funds has become lots more lucrative since the Federal Reserve began raising short-term interest rates two years ago. Thanks to the Fed, money-fund yields have gone from essentially zero in early 2022 to 5%-plus today.

As a bonus of sorts for money fund holders, the significant drops in Fed rates that had been widely expected by now seem to be delayed, perhaps indefinitely. 

And there are even predictions from the likes of rate mavens at Pimco and former Treasury Secretary Larry Summers that the Fed’s next rate change may well be a hike rather than a cut, to help forestall inflation from getting worse.

All this means that for now, thanks to the inverted yield curve that the Fed’s rate hikes helped create, money fund holders are getting higher yields than long-term Treasury holders are getting.  

All of this has attracted lots of interest—yes, you can groan now—from both institutional and retail investors. Money fund assets have risen by 25% from the start of last year through April 11, according to Crane Data. That $1.3 trillion increase has boosted money fund assets to $6.48 trillion. 

That’s a tad lower than the record $6.54 trillion on April 2, which Pete Crane says is because people are taking money fund withdrawals to help pay their income tax bills.

Crane says that the bulk of the increase in money fund holdings came from institutional investors that had bank accounts way above the Federal Deposit Insurance Corp.’s $250,000 insured maximum at the likes of Silicon Valley Bank, which collapsed a year ago.

These days, with stocks lurching up and down, there’s a lot of comfort and safety in money-market funds for retail investors as well as institutional investors. Sure, money funds aren’t exciting. But you don’t have to deal with wild daily or weekly price lurches.

That’s why I say that money funds are tempting. It’s easy to fall in love with reliability and predictability, given the hectic financial and political markets that we’re dealing with. And a 5%-plus yield is pretty nice, too.

But watch out. Don’t fall in love with your money fund.

Sure, it’s great to be getting a decent yield on your short-term money after years of earning almost nothing on it. In fact, as you can see in the nearby chart, rates were so low from the first quarter of 2020 through the first quarter of 2022 that the yield on money funds was significantly less than the dividend income of the

S&P 500.

(The money fund and S&P yield figures are from Admiral shares of Vanguard’s government money fund and S&P 500 index fund.)

That pattern has since reversed itself, of course. S&P 500 and government fund incomes became almost equal two years ago, when the Fed started increasing rates, and money funds now yield about four times as much. 

It’s really comforting to see the nice, high, reliable income from your money fund. But it’s a mistake to consider it a permanent investment like stocks or bonds.

That’s because, among other things, someday money fund yields will fall. And over the long-term, returns on cash have been far lower than stock market returns. According to a recent Vanguard paper, global stocks earned about 6% more a year than cash from 1901 to 2022, and bonds earned about 1.6% more. Compound those differences for 20 or 30 years, and the difference is huge.

I started thinking about this a month ago, when I realized that as a long-time investor who likes to keep a nice cash cushion and now must take substantial required minimum distributions from his retirement accounts, I was starting to fall in love with my money funds. 

Then a few weeks ago, I began talking with Vanguard, which had begun to warn people that investors who equated money fund holdings with long-term investments like stocks and bonds could get hurt. 

I was especially interested in this because suggesting to investors that they keep more money in stock funds and less in money funds goes against Vanguard’s own commercial interest. For example, Admiral shares of Vanguard’s S&P 500 and Total Stock Market index funds have a management fee of 0.04%, while its government money fund Admiral shares have a fee of 0.11%.

Vanguard says that because the firm is owned by its investors rather than by shareholders, its goal is to keep fund costs as low as possible, not to generate as much profit as possible.

In any event, you need to be careful not to be tempted by the safe money fund returns if you have a long time horizon. It’s one thing to earn a nice return on cash. But don’t be tempted to treat money funds as a long-term investment class like stocks and bonds. That would be a long-term mistake. 

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