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 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.
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