Unlike bank accounts, some money funds dish out returns tax-free. What’s more, banks face tighter limits on the types of investments they make and must pay higher overhead to operate bank branches.
Bank or money fund, yields are just plain low now because interest rates are near zero. But with money funds, there could be even more shrinkage soon. Last week the Securities and Exchange Commission approved rules to make money funds safer.
With investing, more safety means lower returns, and money funds are no exception. Don’t expect any big drop - yields don’t have much lower to go. And most managers have been running their funds more conservatively for months now in anticipation of the new rules.
Still, if yields may become even slightly smaller, why stick with money funds? Why not join the crowd that has pulled some $700 billion out of money funds since their assets peaked at $3.9 trillion a year ago?
Well, look before you leap, even if money funds stink now. Once interest rates rise from their current near-zero levels, they could come out looking pretty good. Keep in mind, it’s only a matter of when rates will rise.
Take, for example, short-term bond funds. They’re an alternative many investors are turning to so they can squeeze out a bit more yield than they’d get from money funds.
But good luck if the unexpected happens, and you suddenly need to access your money just as interest rates are rising. When rates climb, bond prices fall. So you could be getting less back than you put in, unlike with money funds offering at least a dollar-for-dollar return.
“The risk of rising rates is that it tends to blow up bonds,’’ says Peter Crane of fund industry researcher Crane Data, publisher of the newsletter Money Fund Intelligence.
Rising rates also could sting investors plucking cash from a money fund to reinvest in stocks.
