With interest rates likely to rise, you'd think the outlook for your money-market mutual funds would be improving. You'd be wrong. Here are better alternatives.
Cash may be king, but it's certainly not getting the royal treatment these days.
After six months of steady outflows, retail investors abruptly poured $3.8 billion into money-market mutual funds in July, according to the Investment Company Institute, despite the fact that these funds are still paying -- quite literally -- nothing. And I've received several questions recently from readers and friends as to their best options for cash.
Clearly, any true cash needs -- an emergency fund, tuition bill, or near-term living expenses for retirees, for instance -- should be in a money-market fund or certificate of deposit, no matter how little they're paying. But surely there are better options for cash reserves above and beyond those needs. Whether you're hesitant to move money into stocks as the market hits another all-time high, or are looking for a place to park your end-of-the-year bonus, or have a vague goal of, say, buying a home in the next two or three years, it's hard to keep all that excess cash in an account that yields zero.
when rates rise, money funds are among the first products to benefit -- but these days, it's likely that the companies intend to pocket the initial additional increase in return to stem their losses.
"It's obviously a bad time for cash," says New York financial advisor Gary Schatsky. "But I'm really no fan of money-market mutual funds -- especially since rates are going to stay close to zero for a long time." Plus, while these funds are safe, they're not guaranteed, and that lack of guarantee usually warrants higher rates than bank products. These days, though, Schatsky advises online bank money-market accounts, which are paying considerably higher rates, and have the advantage of being FDIC-insured up to $250,000 per account. Among the best options: Ally Bank's money-market account, which pays 0.85%. Bankrate.com is a great source for finding rates on bank products, but read the terms carefully and be wary of money-market rates that exceed 1% -- many of them are average yields based on an unusually high "starter" rate; some come with monthly account fees.
WHAT ABOUT ULTRA-SHORT-TERM BOND mutual funds or exchange-traded funds, which are often touted as cash alternatives? "The minute it's not cash, it's an investment," says Dan Wiener a financial advisor based in Lancaster, Penn. "All of those options involve some risk, and most people don't want to take any risk with their cash."
Ultra-short bond funds may react quicker than money funds in terms of yield, but their constant trading means they'll likely lose money in the short-term. "The math doesn't look good," says Christine Benz, Morningstar's director of personal finance. "Even if rates rise, the hit to net asset value could wipe out any extra benefit from the higher yield."
Take a fund most closely associated with cash alternatives, the Pimco Enhanced Short Maturity MINT -0.03% PIMCO Enhanced Short Maturity ETF U.S.: NYSE Arca $101.41 -0.03 -0.03% Sept. 2, 2014 9:46 am Volume (Delayed 15m) : 14,052 P/E Ratio Market Cap Dividend Yield 0.73% Rev. per Employee More quote details and news » MINT Your Value Your Change Short position ETF (ticker: MINT), which was essentially designed to skirt money-market fund rules, investing in the securities that 2010 regulations ruled were too long-term for money funds, but are too short-term for most short-term bond funds. It's a perfectly fine ETF, but its 0.46% SEC yield, based on the most recent 30 days -- a more accurate estimate of future yield than the trailing 12 month average, says Benz -- is almost entirely eaten up by the 0.35% expense ratio, leaving investors with just 0.11% of yield. Granted, that seems appealing compared to 0.02%, but the risk of losing principal isn't worth the extra few dollars.
"Even if you have $1 million in cash, and you can get an extra 95 basis points -- that's $9,500," Wiener says. "Is that going to make a difference in the house you're going to be able to buy? Is that enough to risk actually losing money?"
Short-term and ultra-short bond funds are not cash alternatives, Wiener says -- they're shock absorbers for your investment portfolio. "When the market goes into free-fall, they'll ensure your entire portfolio doesn't go with it," he says. But they're not immune to a market free-fall, either; these funds suffered quite a shock in the financial crash. When the walls come tumbling down, you want your cash to be safe.
For those insistent on taking a bit more risk, stay on the plain-vanilla side. Vanguard Short-Term Investment-Grade (VFSTX), charges just 0.2%, and yields 1.44%. Vanguard Short-Term Tax-Exempt(VWSTX) charges the same, yields just 0.26%, but that income is tax-free.
Finally, another idea for cash management: Paying off debt. "If you have a home equity loan that's just 5%, paying it off with money that isn't earning anything gives you an immediate 5% return," Schatsky says. That could be your best return yet.
Authored by Beverly Goodman via barrons.com.