February 4, 2019: Cash And Money Market Funds: Interests And Safety

Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

For regular SAA and TAA portfolios, the next re-balance will be on Monday, February 11, 2019. You can also find the re-balance calendar for 2019 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

Cash And Money Market Funds: Interests And Safety

In the newsletter, we will look at current cash investment returns and discuss how safe a money market fund is.

Rates continued to rise

The good news for cash rich investors is that interest rates continued to rise until recently. See the following 3-month US Treasury bill yield:

At the moment, the yield of T Bill (3 Month Treasury) is almost 2.4%, compared with 2.35% in November when we last reviewed it.

Similarly, money market funds are paying higher interests too:

Vanguard money market funds yields (as of 2/2/2019):

Name	SEC Yield
Vanguard Treasury Money Market (VUSXX) — minimum $50,000	2.32%
Vanguard Federal Money Market (VMFXX) (Settlement fund)	2.32%
Vanguard Prime Money Market (VMMXX)	2.48%
Vanguard Municipal Money Market (VMSXX)	1.35%

We want to point out that the tax equivalent rate for Municipal money market fund (VMSXX) is only 2.14% even for the highest federal tax bracket (37%), which is meaningfully lower than that of a taxable money market fund.

Meanwhile, major banks are still paying extremely low interests to savers (see November 12, 2018: The Staggering Low Interest Rates From Big Banks):

Savings interest rates from the four big banks:

Bank	Savings Rate
Bank of America	0.03-0.06%
CitiBank	0.03-0.15%
Chase Savings	0.01%
Wells Fargo	0.01-0.1%

It’s amazing to see that the inertia of consumers to stick to a 2%+ lower interest bank account for so long. Though one can argue that money market funds are not as safe as bank savings accounts, but there are still plenty of other high quality banks that pay much higher interests. For example, Goldman Sachs’ online bank Marcus.com is now paying 2.25% in its savings accounts for $1 minimum and without any other restriction.

Safety of money market funds

It’s been long argued that the main difference (or concern) between a money market mutual fund and a bank savings account is that a bank savings account is FDIC insured up to $250,000 while the money market fund doesn’t have any such a protection. In the past, there were some incidents that a money market fund “broke the buck” (i.e. its NAV (Net Asset Value) went under $1, meaning loss of principles). The most famous example is the Reserve Primary Money Market Fund when its NAV fell to 97 cents in 2008. The Reserve fund was one of the largest money market funds at the time, holding over $64 billion asset. The culprit: it held 1.5% short term loans issued by Lehman Brothers which went bankrupt, When the Lehman’s bankruptcy news broke out, investors of the fund became panic and started to redeem, causing the so called money market fund run (similar to a bank run). The fund was forced to freeze redemptions and eventually liquidated its asset to pay back to its investors.

It took more than a year for most investors of the Reserve fund to get back their money. On average, investors lost 0.9% from the fund’s disaster.

While this example often reminds investors of the peril of money market funds, one can closely look at the details of money market funds and understand the major safety concern for these funds.

Generally, as detailed in May 7, 2018: Money Market Fund Taxonomy, a primary money market fund holds commercial short term loans (issued by corporations and non federal government institutions), in addition to federal debts, while a federal money market fund holds only US government backed credits (such as agency loans and Treasury bills).

For example, Vanguard Federal Money Market Fund (VMFXX)’s holdings as of 12/31/2018 are as follows:

	Percent
Repurchase Agreements	16.5%
U.S. Govt. Obligations	31%
U.S. Treasury Bills	52.5%

while Vanguard Treasury Money Market Fund (VUSXX)’s holdings are 100% U.S. Treasury Bills.

A word on Repurchase Agreements: they are essentially U.S. Treasury Bills third parties use as collateral to borrow cash from the fund. In general, the third parties agree to ‘repurchase’ them back at an agreed time (usually within months) with the same principle amount plus interests. Or one can simply look at this as ‘U.S. Treasury debts’ that pay slightly higher interests (than purchased directly from Treasury debt markets). In the event if the third parties can not honor the ‘repurchase’ agreement, the fund can take the bills and redeem from the U.S. government. Thus, it’s as safe as U.S. Treasury debts except it might be slightly illiquid in such a rare event.

Legally investors of Vanguard Federal Money Market Fund are the shareholders of the fund, just like any mutual fund. This fund is owned by its shareholders, not by Vanguard or any mutual fund company (they are merely management contractors). In a rare crisis like the money market run in 2008 (or even worse one when a fund company goes bankrupt), these shareholders legally own the underlying U.S. debts and they can take possession of the securities and redeem them through the U.S. government eventually.

In terms of safety, a federal/Treasury money market fund is almost as safe as a bank asset such as savings account. This is not the case for a Primary Money Market fund that can own non government debts. In fact, as of 12/31/2018, Vanguard Primary Money Market fund (VMMXX) owned a whopping 55.7% foreign/Yankee debts and 6.7% CDs.

That is why Vanguard chooses to use its Federal money market fund VMFXX as its brokerage settlement fund — any customer’s cash is automatically swept into this fund.

Of course, perception wise, bank assets are viewed safer and thus during a crisis, it’s more likely to have a fund run and that will certainly cause some temporary liquidity issue for a fund’s shareholders but for a Federal or Treasury money market fund, it’s impossible to lose the principles as eventually the U.S. government will be the backstop to honor its debts (assuming, of course, the U.S. government is free of any default).

To summarize, conservative investors can choose a federal and Treasury money market fund.

Market overview

Companies continued to report mixed earnings for Q4 2018. Based on Factset, as of last Friday, 46% of the companies in the S&P 500 have reported earnings and the blended earnings growth for the quarter is 12.4%, better than the 12.2% expected on 12/31/2018. However, analysts continued to revise down the 2019 earnings expectation. They now expect negative (-0.5%) earnings growth in Q1 2019 and the full year earnings growth of 5.6%, lower than the previous expectation (6.3%) a week ago. Again, it’s possible that as more companies report earnings, the earnings expectation for 2019 will trend down. We’ll just have to wait and see.

In the meantime, stocks continued to rise. The S&P 500 index is now approaching to a critical technical level — 200 days moving average. At the moment, S&P 500 200 day moving average is at 2741 while the index price is about 2700. Similarly, one can see that the number of stocks in NYSE that exceed their 200 days moving average has risen dramatically:

Stock markets rise and fall are just investors’ emotional and primitive ways to pinpoint the future growth of underlying companies. For now, the vertical and strong rise of stocks shows investors’ fear of being left behind. We again call for sticking to a plan and managing risk accordingly, in an environment of extended markets and high valuation.

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

In terms of investments, even after the recent retreat, U.S. stock valuation is still at a historically high level and a bigger correction is still waiting to happen. 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.

Enjoy Newsletter

How can we improve this newsletter? Please take our survey

–Thanks to those who have already contributed — we appreciate it.

Latest Articles

RSS Feed

Disclaimer:

Any investment in securities including mutual funds, ETFs, closed end funds, stocks and any other securities could lose money over any period of time. All investments involve risk. Losses may exceed the principal invested. Past performance is not an indicator of future performance. There is no guarantee for future results in your investment and any other actions based on the information provided on the website including, but not limited to, strategies, portfolios, articles, performance data and results of any tools. All rights are reserved and enforced. By accessing the website, you agree not to copy and redistribute the information provided herein without the explicit consent from MyPlanIQ.