May 7, 2018: Money Market Fund Taxonomy

May 8, 2018 | Asset-Allocation, Bonds, Economy, Feature, Gold, Headline, Income, Investments, IRA, Markets, Mutual-Funds, Newsletter, Retirement

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Money Market Fund Taxonomy

As interest rates continue to rise, cash and cash equivalent are becoming more important. Money market funds, one type of cash equivalent, are becoming main force in one’s investments in the current environment.   

Long term readers probably have known that we put quite some emphasis on cash and bonds. To the extent investors finally get used to the concept of low cost investing, we believe cash and bonds, the ‘boring’ investments, will become the next frontier for investors to squeeze out more returns without increasing risk, a true free lunch. 

Rates are rising

The following shows the trend of 3 month Treasury Bill (T Bill) yields. T Bill that’s mature in 3 months is widely used as the definition of ‘cash’. 

Cash yield is now crawling back to a level in 2008, though it still has a long way to go to a level like 3% to 5%. 

In fact, one year T Bill is now yielding 2.28%. These short term yields are now fairly competitive compared with the 1.84% yield of S&P 500 (SPY ETF). 

It’s interesting to see that short term T Bills have higher yields than CDs with the same maturity. For example, the highest yielding 3 month CD in Vanguard (in the above table) only yields 1.75%, lower than 1.87% of 3 month T Bill. We discussed this phenomenon in our previous newsletters such as March 19, 2018: Treasury Bills vs. Brokered CDs. We believe the likely explanation is the pace of interest rate rising — faster than the willingness of CD sellers to adjust their rates. 

Unfortunately, stocks are now at a very high valuation level by many known long term standards. It’s likely stocks in general will return negative in the coming decade. With cash becoming more appealing, this could only exacerbate their volatility and low returns. 

Furthermore, compared with longer term bonds, in such a rising rate environment, bond funds such as VBMFX (Vanguard Total Bond Market Index Inv) and even those with a stellar record such as PONAX (PIMCO Income A) are losing money at the moment. So cash or cash equivalent are becoming the go to shelter, at least at this moment. 

Types of Money Market funds

In addition to purchasing T Bills directly from your brokerage accounts (you can purchase those with even shorter maturities such as 2 weeks or one month T Bills), you can invest in money market funds. Money market funds invest in T Bills, CDs, short term loans and bonds. They generally have a rigorous risk control so that

  • Their NAV (Net Asset Value) is maintained as 1.00. Unless in a very rare situation, their value is guaranteed to be $1.00. 
  • The debts invested should have weighted average maturity maintained within  60 days. Furthermore, no security can have maturity longer than 13 months. 

The advantage of investing in a money market fund is that you can withdraw from it any time, more liquid than a T Bill or CD. 

Vanguard brokerage offers some of the lowest fee money market funds. The following table shows yields of the 3 types of money market funds in Vanguard: 

Vanguard money market funds yields (as of 5/7/2018):
Name SEC Yield
Vanguard Treasury Money Market (VUSXX) 1.63%
Vanguard Federal Money Market (VMFXX) (Settlement fund) 1.59%
Vanguard Prime Money Market (VMMXX) 1.83%
  • Treasury money market fund: it is limited to only investing in Treasury Bills, which are considered the safest securities in the world. 
  • Federal money market fund: in addition to T Bills, it can also invest in other government agency related bonds including those from the Federal Housing Administration (FHA), Small Business Administration (SBA), Government National Mortgage Association (GNMA), and Government Sponsored Enterprise (GSE) such as Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage (Freddie Mac), 
  • Prime money market fund: in addition to T Bills and government agency bonds, it can also invest in CDs and corporate bonds. 

One can see as restrictions lessen, prime money market funds should have higher yields than federal money market funds which in turn should have higher yields than Treasury money market funds. 

Vanguard Federal money market is also a settlement fund, or so called sweep fund by others. It’s a fund that allows investors to automatically ‘sweep’ to  or park cash to once they sell their securities such as stocks or funds. 

It’s interesting to see that at the moment, Vanguard Treasury money market fund yields slightly higher than the Federal money market fund. 

Vanguard prime money market fund is yielding about the same as the 3 month T bill. In a more normal environment, one can expect a prime money market fund should have comparable yields as 3 to 4 month T Bills. 

For comparison, the following are the money market fund yields from Schwab and Fidelity.

Name SEC Yield
Schwab Value Advantage  1.7%
Schwab Cash Reserve (Sweep) 1.35%
Fidelity Money Market 1.68%
Fidelity Government Cash Reserve (Sweep) 1.38%

Vanguard offers the best money market rates. 

How to utilize high money market fund yields

Unfortunately, banks and many other brokerages are still slow to offer compelling rates for checking, savings accounts or money market funds. However, for cash investment purpose, one can utilize ACH electronic transfer in between your bank and Vanguard brokerage to obtain higher returns.

For example, you can open a Vanguard (or Schwab or Fidelity if you prefer) account, link your bank account to this brokerage account. You can then use electronic ACH transfer to transfer your money from/to the bank account. It generally takes 2-3 business days to process an ACH request although recently, there has been a push for institutions to offer expedite one day ACH transfer. 

To summarize, money market funds are now offering compelling rates. To get a higher rate (in Vanguard case, 0.2% difference), you can invest in prime money market funds that usually yields highest. Furthermore, one can utilize electronic transfer such as ACH to take advantage higher money market yields from other institutions. 

Market Overview

Now that 81% of S&P 500 companies have reported earnings for Q1 2018 (by Friday last week), we can almost claim that Q1’s earnings growth is stellar: the blended earnings growth is 24.2% vs. the expected 17.1% on December 31, 2017. In fact, if the trend continues, this would mark the highest earnings growth since Q3 2010 (34.0%). Unfortunately, stocks continued to wobble last week. Markets are more forward looking. Often a market downturn starts right at a very high earnings growth or very low unemployment level. So while we celebrate the good news in the past, we should be cautious to manage our risk exposure to a comfortable level. This is especially true in a rising rate, over extended and over valued market. 

As always, stay the course. 

For more detailed asset trend scores, please refer to 360° Market Overview. 

Now that the Trump administration has been in the office for more than a year, the economy and financial markets are in general still in a good shape. Whether the economy will continue to benefit from the supposedly trickle down of the tax cut, the deregulation, and the promised infrastructure spending remains to be seen.  On the other hand, stocks continued to ascend, regardless of the progress. Looking ahead, however, we remain convinced that markets will experience more volatilities at some point when reality finally sets in. 

In terms of investments, U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic about U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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