What're the best -- and worst -- ways to play the super hot money-market game?
For starters here's a shocker: If you bought one of those high-yielding six-month money-market certificates offered by the banking fraternity, you've locked yourself into an "inferior investment."
That's probably a hard argument to buy, considering that they're the single most popular money-market investment. John Q. Public has socked away $409 billion in these certificates -- that's more than half the public's total MM investments of about $700 billion. And at their current yield of nearly 14.7 percent, the certificates are doing precisely what they're supposed to -- namely, outstrip the going 12.4 percent inflation rate.
Nontheless, one leading money-market expert, 39-year-old William Donoghue, contends that the certificate buyers are shortchanging themselves on the amount of interest they can realize on their investment by ignoring the higher-yielding money-market alternatives.
Specifically, he tells me you can earn 7 1/2 percent more interest on Treasury bills than on the MM certificates. And on the MM funds -- Donoghue's favorite MM investment -- the interest runs 10 1/2 percent higher than on the certificates.
The expert publishes Donoghue's Money Letter, a monthly -- soon to be biweekly -- report out of Holliston, Mass, that deals with MM investments available to individuals at $10,000 or less. He's also the author of the recently published "Wm. E. Donoghue's Complete Money Market Guide," [and distributes Money Market Mutual Funds, a regular Washington Business feature].
Now to his argument for shunning those six months certificate in favor of the alternatives.
If you bought a certificate and annualized the return over a year -- let's say at the current 14.68 percent yield -- your interest, as you can see, is just under 15 percent. And that's it.
But take a six-month T-bill which currently carries a yeild of 14.43 percent. You buy that at a discount -- which means you get a check for $721 back from Uncle Sam after the purchase. Thus, you're anteing up $9,279 to get back $10,000. When the final bucks have been returned to you, your coupon-equivalent yield comes out to 15.78 (which amounts to about 7 1/2 percent more interest than on the certificates).
Donoghue explains it, not only is the return better on the T-bill, but it's safer, more liquid and also exempt from state and local taxes. And if interest rates decline, your T-bill will go up in value (presuming, of course, that you sell it).
All told, the public is presently holding about $23 billion worth of three- and six-month T-bills.
Next, the comparison of certificates and MM mutual funds (which invest in such things as T-bills, certificates of deposit of leading banks and the securities of such U.S. government agencies as the federal Home Loan Board).
Since MM fund yields change every day (depending on the interest-rate fluctuations), wouldn't it be better, I asked Donoghue, to have a guaranteed six-month return, as offered by the MM certificates?
Absolutely not, he replied, pointing to a study by the Fidelity Daily Income Trust (a leading MM fund) which demonstrates greater returns in the funds than on the certificates.
The study measured the performance of its own fund (which is thought to be typical of the industry) over 84 time periods and that of the MM certificates. The starting date was June 1978 -- which is when the banking fraternity got the green light to offer mM certificates.
The results: an average 11.43 percent return for its own fund vs. 10.4 percent for the MM certificates.
At present, the average MM mutual fund -- there are slightly over 100 with assets of $86.8 billion -- is yielding about 16 1/2 percent.
Donoghue thinks the public's single best MM bet right now is the MM fund with very short maturities on its securities (less than seven days). The reasoning: they have the ability to capitalize faster on rising interest rates (which is where Donoghue believes rates are headed).
The industry average is presently about 29 days, which signifies to Donoghue that most MM fund managers are betting on rising rates. If they thought rates were headed lower, they'd lengthen the maturities to around 40 to 45 days.
Donoghue regards the average maturity of the MM mutual fund industry an excellent barometer of where rates are headed. It's never really dramatically wrong, he says.
Accordingly, Donoghue thinks MM investors should make a point of shying away from MM mutual funds with longer maturities -- such as Steadman Federal Securities of Washington, D.C., which, as of late last month, had an average maturity of 68 days.
There are a variety of reasons given for the prospect of higher rates. Donoghue thinks the most cogent one centers on some $180 billion worth of MM certificates that will be coming due in March and April. If rates should fall, you could see a mass exodus from these certificates and into the higher-yield MM funds, explains Donoghue. And since MM certificates account for a disproportionate amount (in some cases 20 percent) of the dsposits of some smaller banks and savings and loan associations, any major withdrawals could immediately put them in hot water.
To prevent what could be a slew of insolvencies, it's Donoghue's view that the Federal Reserve -- which is aware of the danger -- will move to ensure that rates remain relatively high.
But what happens if he's wrong and rates fall?
In that case, the single best MM investment -- and a current favorite -- is the Merrill Lynch Corporate Income Fund (Short-Term Series), says Donoghue. It's a unit investment trust, with units running $1,000 each. The fund invests in CDs, and Merrill Lynch will buy back the units without commission. In a declining environment, they will outperform both T-bills and MM certificates and Donoghue figures they should yield about 17 percent over the next six months.