Money Funds Advice Goes Against Grain : Investments: Some analysts are defying prevailing wisdom by pushing lower short-term yields now in hopes of higher returns later.

It takes nerve to recommend an interest-bearing investment paying out less than 5% over one that yields 7.5% or 8%.

But that’s just what some financial advisers are doing right now, in defiance of the prevailing wisdom.

Many savers of late have been fleeing the depressed returns of the short-term money markets for the greater yields of long-term alternatives such as bonds and bond mutual funds.

A few analysts argue that those people may be making a classic error in timing.

“The puny yield on money-market investments is encouraging many investors to lengthen their maturities in quest of higher returns,” says Norman Fosback, editor of the advisory service Income & Safety in Ft. Lauderdale, Fla. “That is the wrong step.”

Or as James Grant, editor of the New York-based Grant’s Interest Rate Observer, puts the argument: “People are in full flight from cash. They want zippy common stocks, high-yield bonds, defaulted Peruvian bank loans, collateralized mortgage obligations and intermediate-term bond funds.

“On form, they should suffer low (Treasury) bill rates rather than reach for the overpriced, longer-dated alternatives.”

The theory they propound isn’t very complicated at heart. In fact, it is little more than a variation on the old precept “buy low, sell high.”

But it can be difficult to put into practice, if only because it requires time and patience before it has a chance to pay off. Though it has historical precedent on its side, it comes with no guarantee.

How could a money fund yielding 4.9% wind up eventually paying more than a bond fund yielding 7.9%?

Suppose interest rates, at some unknown time in the near future, begin to rise. Since money-fund yields tend to follow market trends with a lag of just a few days, weeks or months, their yields would soon climb on a parallel path.

At the same time, rising rates would push long-term bond prices, and the net asset values of bond funds, lower, offsetting some or even all of the return produced by the bonds’ interest payments.

Fosback says he bases his position on the expectation that the government will do whatever it must to stimulate the economy by election time in 1992.

“As economic growth revives, interest rates will rise, and bond fund prices will fall,” he says. “That is why we continue to advise keeping portfolio maturities short.”

The principle was demonstrated in reverse at the beginning of the 1980s, when a surge in inflation drove bond interest rates to lofty levels, and short-term rates even higher.

Faced with a choice of long-term government bonds yielding 12% to 13%, and money-market returns that sometimes surpassed 15%, many savers naturally went for the “extra” offered by a money fund or short-term certificate of deposit.

But the bonanza in the short-term markets proved fleeting, while bond investors were able to lock in double-digit bond returns for years to come.

Said noted investment manager George Soros, as quoted in the book “The New Money Masters” by John Train: “The best time to buy long-term bonds is when short-term rates are higher than long-term rates.”

Grant offers an explanation for all this: “The paradox is grounded in logic.

“By the time that money-market instruments have become seemingly third-rate investment vehicles, stock and bond prices have frequently had their run.”