Unwelcome in some corners, higher interest rates have translated to good news for savers, who are seeing decent returns on cash held in money-market mutual funds for the first time in several years.
After a long period of low returns, average money rates are approaching 3 percent, and some experts say they may hit 5 percent by 2006 if the Federal Reserve stays on its current course. The jump in money-market rates has been spectacular over the last 14 months, with the yield on the average taxable money fund rising more than fivefold, from just over half a percent in June 2004 to 2.89 percent last week -- the highest weekly average since Sept. 18, 2001, when it stood at 2.98 percent, according to the Money Fund Report.
"We're seeing interest in cash for the first time since 2001, practically, and we expect the interest to only grow as rates continue to rise," said Peter G. Crane, managing editor of iMoneyNet, publisher of the Money Fund Report. "Yields are still digesting the Aug. 9 Fed hike and beginning to anticipate an almost certain Sept. 20 rise, so we should see yields break through 3 percent and keep going."
Judging from the fed funds futures market, the top-yielding money-market funds could easily strike 5 percent next year, Crane said. That's far from the highest annual rate of almost 17 percent in 1981, but it's an important psychological level of return for cash savers.
Asset flows into money funds have begun to pick up as well, after nearly four years of declines. Money fund assets peaked at about $2.2 trillion at the end of 2001, but had lost nearly $400 billion by the beginning of this year, a drop of almost 20 percent. Total assets have grown by $57.14 billion since mid-July, however, and now stand at more than $1.9 trillion.
For the last several years, investors of all stripes have been loath to hold much money in cash because it offered such a dismal return. Some sought better yields in short-term bond funds or certificates of deposit, but for most people, finding a good vehicle for saving money needed in the near term, such as for tuition or a down payment on a home, has been a challenge.
Higher rates on money-market funds make life a bit easier for savers, and may help ease the pain of retired investors who have been hard-pressed to squeeze much more than 2 percent from their cash holdings. It also makes procrastination a more palatable option for anyone who would rather park money on the sidelines than risk it in the equity market, Crane said.
"The saying goes, it's not bulls, not bears, but chickens who put their money in cash, they park it there and wait for better opportunities," Crane said. "So those chicken investors, and retirees and income investors, have reason to be thrilled about the rates, because for the first time in a while they're going to be paid decently to sit there."
When considering cash alternatives, the first decision to make is whether you want a money-market account, a money-market mutual fund or a CD. When you'll need the money should dictate your choice.
Money-market accounts and money-market mutual funds offer the advantage of liquidity -- you can withdraw money at any time -- but you may pay for that by earning a lower yield. CDs, which require you to commit for a fixed period, usually six months or longer, may pay a better yield, but typically charge a penalty for early withdrawals. In addition, the yield on money-market accounts and mutual funds fluctuates, while rates on CDs are fixed.
Another key difference is that CDs and money-market accounts are covered by the Federal Deposit Insurance Corp., while money-market mutual funds are not. This should not necessarily drive your decision, however, as the risk in money-market mutual funds is extremely low.
With money-market mutual funds, the single most important factor is cost, said Christine Benz, associate director of fund analysis at Morningstar Inc.
"It's a point I'd make regarding any mutual fund, but it's particularly important in a mutual fund type where you expect a low absolute return," Benz said. "If you're paying 1 percent in expenses and you're earning just 3 percent, you're forking over literally a third of your return."