Managing Money : Money Market Funds Show New Appeal

Don’t look now, but plain old boring money market funds are looking pretty attractive these days. But a little careful shopping for the right fund won’t hurt.

Recent rises in interest rates have given money funds their best yields in over three years. The average seven-day yield has risen to 7.27%, the highest since June, 1985, according to Donoghue’s Money Fund Report in Holliston, Mass.

That compares quite favorably to the funds’ chief competitors, bank money market deposit accounts. They have been slower to respond to rising rates and thus are yielding an average of only 5.94%, according to Bank Rate Monitor in North Palm Beach, Fla.

“This is a real good time to be in money funds,” says William E. Donoghue, publisher of Donoghue’s Money Fund Report.

What’s more, most economists and money managers expect interest rates to continue to rise. If they are right, it would behoove you to keep your savings in shorter-term vehicles such as money funds, whose yields will rise with rising interest rates, rather than longer-term certificates of deposit, whose yields are fixed.

As evidence of the rising-rate convictions of market pros, securities in money fund portfolios are carrying an average maturity of 33 days, the shortest in six years. “That means the smart money believes interest rates will rise,” Donoghue says.

Higher yields, along with continued post-crash jitters about the stock market, have resulted in a boom in money funds. At least 80 new funds have started since last October’s stock market crash, raising the total to at least 509, says Susan M. Cook, editor of Donoghue’s Money Fund Report.

But even though many investors are putting more dollars into money funds, not all shop carefully for them, thinking they are all about the same. In fact, however, funds vary widely in yields, safety and expenses, as a quick scan of Thursday’s listing of money fund yields in The Times will attest. Some funds are offering yields as high as 8%, while others are as low as 6.3%.

Experts offer a number of tips in shopping for money funds:

- Look beyond yields and examine expense ratios. A recent study by Donoghue’s Money Fund Report shows a direct relationship between fund expense ratios--management fees and other operating costs as a percentage of assets--and net yields. The study shows that expenses have a bigger effect on yield than any other factor, including composition of the portfolio.

The highest-performing funds have ratios as low as 0.2% of assets, while the lowest performers incur costs as high as 1.44%. Some higher-cost funds charge so-called 12b-1 fees, which are annual fees used to pay marketing expenses that directly erode your net yield.

To be sure, these expenses are already reflected in the yields you read in newspaper listings, so you don’t need to do any mathematics now. But funds with lower expenses now are likely to have lower expenses in the future--and that most likely means better future performance.

- Look for funds with conveniences and services. Does the fund offer check-writing privileges? Can you switch your money into other funds offered by the same fund family?

- Examine whether the fund’s yield reflects higher risks or other gimmicks. To boost yields, some funds aggressively invest in riskier securities such as lower-rated commercial paper issued by troubled corporations, or debt obligations of troubled savings and loan firms.

Also, some newer funds artificially inflate their yields by absorbing part or all of their expenses--meaning they take it out of their profits rather than your yield. That’s awfully nice of them. However, these funds usually stop this practice eventually--and their yields then often drop dramatically, sometimes by as much as half a percentage point, Cook of Donoghue’s Money Fund Report says.

Funds currently engaging in this practice include Evergreen Money Market Trust, with a current seven-day yield of 7.7%, and Alger Money Market Portfolio, yielding 7.89%, she notes.

- Consider larger funds. Funds listed in The Times, for example, have a minimum of at least $100 million in assets. These larger funds will tend to have lower expense ratios, since they can spread their management fees over a greater amount of assets, notes Steve Janachowski of Brouwer & Janachowski, a San Francisco money management firm. These funds also will incur lower commissions and other transaction costs and tend to offer more services.

- If you’re concerned about safety, buy money funds investing strictly in government-backed securities. Although no one has ever lost a penny in money funds, they are not federally insured and so technically are not as safe as savings accounts. But funds investing solely in U.S. Treasury securities or other government-backed debt provide that safety, and they typically yield only about half a percentage point less than regular money funds.

Another safety-conscious alternative: Invest in several funds to spread your risk.

- Be wary of funds that lack a track record. Funds that have been around at least two or three years will give you a reliable way to judge their future performance. Call them for their average yields for the past few years.

Cook of Donoghue’s Money Fund Report says funds with consistently strong long-term performance records include Vanguard Money Market Reserve Prime, offering a current seven-day yield of 7.8% thanks largely to a low expense ratio of 0.34%. She also cites Kemper Money Market Fund, yielding 7.8%, and Strong Money Market Fund, yielding 8.0%.

Cook also likes Flex-Fund Money Market Fund, yielding 7.8%. It will absorb expenses in order to keep its yield in the top 10 of funds overall, Cook says. While that practice is of concern for new funds, since this fund has been doing it since its inception in 1982, it is likely to continue the practice, she says.

Bill Sing welcomes readers’ comments but regrets that he cannot respond individually to most letters. Write to Bill Sing, Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.