Money-market mutual funds, languishing since the financial crisis and Great Recession, are starting to yield better returns — making such funds an increasingly attractive vehicle for savers, as well as for investors earning only minuscule rates in their brokerage "sweep" accounts.
SMI managing editor Matt Bell offered a brief overview of money-market funds this week on Moody Radio's MoneyWise Live.
To listen, click the play button below — or scroll down for a transcript. (For more radio appearances by members of the SMI team, visit our Resources page.)
MoneyWise Live, hosted by Rob West and Steve Moore, airs daily at 4:00 p.m. ET/3:00 CT.
To ask a question on a future program, call 1-800-525-7000 and mention you have a question for either Matt Bell or Mark Biller of Sound Mind Investing.
Steve Moore: Well Rob, Matt Bell has been with us numerous times in the past and as managing editor over at sound mind investing. He lives and breathes biblical but also practical investing principles.
Rob West: Yes, he certainly does. Not only that he's a great friend. And Matt, welcome back to MoneyWise Live.
Matt Bell: Rob and Steve, it's always great to be with you guys.
Rob West: Well, we're going to dive into hopefully a real practical and helpful topic today for those folks looking for somewhere to park their emergency savings in particular. And I think we should clear something up first. A lot of folks confuse money-market funds with money-market accounts. Why don't you start there with the difference today?
Matt Bell: Yeah, that's a great starting point because you're right. I mean they sound so similar that they end up creating a lot of confusion in people's minds. So money-market funds are offered by brokers like Fidelity and Vanguard and Schwab and they are mutual funds. So that means they're investments. And that means they carry some investment risk. Those risks are relatively low, but they do carry some investment risk. Money-market accounts, on the other hand, are offered by banks and credit unions and they don't carry investment risk. So that's a good starting point to think about the distinctions between those two.
Rob West: Yeah, absolutely. Now money-market funds in particular got a bad rap during the Great Recession about 10 years ago. Tell us about that.
Matt Bell: That's right. It requires a little bit of a history lesson and a little bit of understanding of how these money-market funds operate. I think it can be helpful to understand that with a money-market fund — what the companies do with the money that you or I put on deposit with the money-market fund is they invest that money in things that most of us would consider pretty safe, like Treasury bills, but also in some things that people may not be so familiar with, like commercial paper, which, in essence is a short-term loan made to a corporation.
So there was a time when money market funds like Vanguard's money-market fund was paying a pretty impressive 5% back in 2007. But there was one fund back during the Great Recession in 2008, the Reserve Primary Fund, that had some money invested in Lehman Brothers — with Lehman Brothers commercial paper. And when Lehman Brothers went under, that ended up meaning that that fund lost money which was a shock to a lot of people who didn't think they could lose money in a money-market fund.
Rob West: Yeah, well and that obviously colored the way people look at these funds moving forward. But you're making the case — and we didn't mention but you wrote a great article on this that folks can find that on SoundMindInvesting.org, right there at the top — you make the case that they're making a comeback. Why is that?
Matt Bell: The interest that they are paying is is inching up and now it's pretty respectable. For a long time after the Great Recession of 2008 and 2009, money-market funds were paying almost 0% interest, but they've been edging up. As the Federal Reserve has raised interest rates, those funds are able to generate more on their investments — and so they've been passing along those gains to those who invest in their funds, and therefore some of those funds are now paying over 2%.
Rob West: Yeah, and so that's obviously now something we can consider as we think about our emergency savings because you would still classify these as safe, correct?
Matt Bell: I do still classify them as safe. But I would say that that even at about 2%, they still may not be worth the risk for people who have some other alternatives like an online bank. Because online banks where you're not going to lose money — you're not putting money at risk, you're not investing that money — some of those online banks are paying about the same; they're paying 1.85–1.9%. And without having to take any investment risk — even the smallest the risk that may be associated with the money-market fund. That still may point people back toward the online banks right now.
Rob West: Yeah, we're going to get into the safe deal a little bit deeper here in a moment and talk about everything you need to know.
Rob West: The title of the article is Money-Market Funds Are Back in the Game. And a lot of that has to do with the fact that these were out of favor following the Great Recession because we saw one of these money-market funds “break the buck” — which meant it had a net asset value of less than a dollar, where they're all intended to stay. What happened to bring more safety to the table? You began to talk about this a little bit, but give us a deeper dive into how safe these really are now.
Matt Bell: Yes. So I mean there is still an element of investment risk with money-market funds. But since the problems of 2008 and 2009, there have been some new regulations that money-market funds operate under where they have to maintain a certain amount of liquidity for redemptions from people who have money invested in those funds, and they do need to manage their risk in a more stringent way. So there have been a few additional safeguards added since then. And, like I said, I don't want to overstate the risk but there is that distinction between money-market funds and money-market accounts — you have to realize that with the money-market fund you're basically still making an investment.
Rob West: Yes, absolutely. All right. So we have money-market funds we have money-market accounts. You've also mentioned online savings accounts. How would somebody listening today understand — based on their situation — which direction they should go with their emergency savings?
Matt Bell: I think the landscape looks like this: Traditional banks versus online banks versus money-market funds. A traditional so-called brick-and-mortar bank is probably honestly your worst option in terms of interest these days. I mean the bank where we have a checking account is paying .01%. If you had $15,000 in there, at the end of a year you would receive a whopping $1.50! That's kind of a nonstarter.
But online banks, they're paying more respectable interest rates. They're paying 1.85–1.9% — and with FDIC insurance. And so if you're willing to bank online you can get a much better interest rate by doing that.
Then the money market funds, they are a factor but they're a factor really for people who are investing — people who have an investment account at a broker.
Sometimes there is a certain amount of their investment portfolio that's not really invested in mutual funds or stocks or such and so that money needs to be someplace and that's called a "sweep" account. There is a trend these days where some of these brokers are sweeping that money into deposit accounts that are paying very little interest. But you do have a choice in most cases to move that money into a money-market fund where you can get a little bit better return on your money. So for investors with uninvested money in their portfolio, a money-market fund can still make sense.
Rob West: Yeah, that makes a lot of sense. Matt, How would you go about making sure first of all this sweep account — that is the money fund inside an investment portfolio where any proceeds would go after sales or any new deposits —making sure that that's the right type of fund and that there's a respectable yield attached to it?
Matt Bell: It's really not that difficult if you go online to take a look at your account and click on whatever it is that is listed there as having your cash — your uninvested money — you'll be able to find out some information about that, and typically some options. At Fidelity, for example, you've got three different options for your sweep account. One of those options is a money-market fund. It's not their highest-paying money-market fund but it's certainly better than the deposit account, which is one of the options.
Rob West: Yeah, very good. Now, Matt, for somebody who has a healthy investment portfolio they have 401(k) they're allocating 15%. They're taking advantage of the [employer] match. Perhaps they have some other investments happening elsewhere. They really struggle with this idea of: “Yeah I know I should have some emergency savings but it's just not worth it because I'm not getting any return.” How do they process that and understand the value of it?
Matt Bell: It's a great question especially in this day and age with the market doing so well for so long. People can kind of move past the financial "blocking and tackling." And yet the financial blocking and tackling — meaning having some money in an emergency fund — is essential when times are good or times are bad. You don't want to get caught off guard — that if you need a chunk of money to cover some unexpected expense and might have to sell an investment and perhaps the market isn't doing so well at that time.
So to have some money in reserve is biblical for one thing. Proverbs 21:20 says, "In the house of the wise are stores of choice food and oil. But a foolish person devours all that they have." And it just makes sense from a very practical level as well.
Rob West: Yeah, I like that. All right, let's talk about the person who's living on their investments — they've got a lifetime of savings they've been putting away there. [Now,] in that retirement season, perhaps redirecting their time and energy to full time Christian service, but drawing an income from their investments where they still have an allocation towards stocks, but they also have some cash and cash equivalents. How much would you recommend they have for the average person in cash-like investments to be able to draw from in the event that the bull market turns over in the next couple of years?
Matt Bell: It's a tough question to generalize about, but I'll take a stab at it. One way to approach that is to do the old asset allocation thing. So there are some online tools you can use. Vanguard has a good free tool you can use to figure out your appropriate asset allocation between stocks and in more conservative things like bonds and cash. And that can point you to a proper asset allocation mix for your portfolio based on your age and goals and such.
Another thing that's popular — especially with more conservative investors — is to maintain a significant cash position of two to three years worth of living expenses that wouldn't otherwise be covered by things like Social Security or other guaranteed income-producing sources in retirement. That can be tremendous peace of mind for someone that in a market downturn you don't have to sell a portion of a declining portfolio balance. You've got the money there. And so the idea is that when times are good and the investments are generating a return, you're refilling that cash account — the cash bucket, so to speak. When times are bad, instead of taking money out of that investment portion of the portfolio you're taking money out of that cash portion.
Steve Moore: For these smaller investors, Matt, how much money is the minimum if I wanted to put something into a money-market [fund].
Matt Bell: The minimum required by the by the money-market fund itself?
Steve Moore: Yes.
Matt Bell: In some cases, it's zero or $1. Fidelity has a money-market fund that requires no minimum. At Vanguard, there is a $3,000 minimum, so it will vary by fund provider.
Steve Moore: All right. And then how liquid is this? If I have $5,000 or $10,000 in a money-market fund and all of a sudden I have an accident at my home — there's water damage, I need that money quick to hire some help — how quickly can I get it out?
Matt Bell: Typically with a money market fund you would have access to that money the day after you make the request.
Steve Moore: OK. All right.
Rob West: You know, Matt, as we wrap up here today — and really appreciate this valuable information — you know there are some folks that hear you mention the Proverbs passage and say, "Yeah, but are we supposed to put our trust ultimately in the Lord. And this idea of an 'emergency fund' kind of flies in the face of that." What would you say about really a biblical understanding of why it's important to have some savings even if our heart is ultimately dependent upon the Lord?
Matt Bell: It's interesting that in both Proverbs 21:20 — which I quoted earlier — where you're not saving anything, the Bible calls such a person foolish. And on the other end of the spectrum, in the Parable of the Rich Fool in Luke 16, the person who has so much in reserve and is spending time building bigger barns to hold all the surplus, they're called a fool as well. So somewhere in between those two extremes is the wise level of savings.
But I think the idea that we're trusting the Lord, of course, is correct. I also think it's something you can't just slap on like cologne. You have to live a little and go through some tough times and realize your dependence on God and His provision. And so I think we can learn the Scriptures and it's important to have the Scriptures in mind — and then do what the Bible says, and the Bible says to maintain a reserve. But ultimately, as you're saying, our ultimate provider is, of course, the Lord.
Rob West: I love it. We need to put our hope in God, not in our things. Matt Bell, always a great pleasure to have you along with us on MoneyWise Live.
Matt Bell: Good to be with you guys as well. Thanks so much.