As the Federal Reserve was slashing interest rates in recent weeks, billions of dollars in investor money was flowing into some of the most...
As the Federal Reserve was slashing interest rates in recent weeks, billions of dollars in investor money was flowing into some of the most rate-sensitive investments out there, into funds that are almost certain to have a tough time keeping up with inflation.
The flight to safety is, for many people, seen as a way to minimize risk. In fact, it’s just turning from one form of risk to another and, given current market conditions, puts savers in a situation most will hate. Money-market mutual-fund assets now stand at a record of $3.27 trillion, according to Money Fund Report, a service of iMoneyNet of Westborough, Mass. In the week following the Fed’s first rate cut, some $57 billion moved into money funds, and recent trends are showing no signs of slowing.
That money hardly has attractive rates. Money Fund Report shows the average money-market fund has a yield of 3.17 percent; competitor Crane Data shows the average rate on the 100 largest money funds at 3.66 percent.
Officials at both of those research firms suggest that eventually the average money fund will yield about 2.5 percent.
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With inflation standing at 4.1 percent, as measured by the Consumer Price Index in 2007, that’s a problem.
Risk comes in many different forms, but the one that many people are most fearful of is market or principal risk, the chance of losing their money in the stock market.
If someone pulls out of the market and goes entirely into a safe haven like a money-market fund, they zero the principal risk, but they give a big hug to purchasing-power risk, which is the possibility that their money will not grow at a rate that keeps up with inflation.
Being on the wrong side of inflation risk is a minor problem if it doesn’t last too long. But many investors pay little attention to how they invest their cash, thinking they will park the money while they wait for the next opportunity and not worrying about the payout on that cash.
Over time, however, that money tends to get sticky, and stays where it has been left, without much regard to the payout. (How else can an investor explain leaving their money in a low-paying brokerage sweep account indefinitely, when they could direct the cash into something better?)
Money-market funds are built to be ultrasafe investments, but they are also the one part of the fund world where chasing performance is acceptable; going for funds that top the performance charts is a good way to get the best, most competitive yields.
The investor who then stretches further for yields — abandoning money funds — winds up taking on other risks, and may allow principal risk to creep back into the picture. That’s not horrible; it just paints a picture of why investors need to embrace a variety of asset classes and take on a range of risk types.
Chuck Jaffe is senior columnist at MarketWatch. He can be reached at email@example.com or Box 70, Cohasset, MA 02025-0070.