As Fed raises interest rates, money funds increase yields, some to more than 1%

Clients won't get rich, but at least they'll get more than zero

Mar 31, 2017 @ 12:18 pm

By John Waggoner

Thanks to the Federal Reserve's recent interest-rate hikes, some money market funds are doing things they haven't done in a decade: Paying 1% interest. Your clients won't get rich on their money fund holdings, but at least they'll get more than zero.

According to Crane Data, four institutional money funds and three retail money funds now pay 1% or more. The highest-yielding money fund, Fidelity Investments Money Market (FNSXX), now yields 1.06%, while Morgan Stanley Institutional Liquid MMP (MPUXX), now yields 1.05%.

Investors have $2.65 trillion in money market funds, according to the Investment Company Institute, the funds' trade group. Yields hovered near or at zero until December 2015, when the Fed pushed rates from zero to 0.25%. Many of those zero yields were subsidized by fee waivers from the fund sponsors, and in some variable annuity and retirement accounts, yields fell below zero.

The majority of money funds are well below 1%, says Peter Crane, president of Crane Data: The 100 largest money funds yield an average of 0.60%. Those yields should rise slightly as they digest the Fed's March 16th rate hike. The typical money fund has an average weighted maturity of about 35 days, meaning it takes a bit more than a month for money funds to feel the full effect of rising rates.

Several banks are offering money market accounts with yields of 1% or more, according to Bankrate.com. While national average yields on bank money market accounts are a subterranean 0.11%, top-yielding accounts pay an average 1.15%. Current highest yield in the New York City area: 1.25% at PurePoint Financial for accounts with a $10,000 minimum.

Bank certificate of deposit rates are heating up as well. A Capital One five-year CD now yields 2.3%, according to Bankrate.com. The bank offers a two-year CD yielding 1.60%. "I think the one-year area is the sweet spot," said Greg McBride, chief financial analyst for Bankrate.com. "You get a premium over liquid accounts, but beyond one year, the yield premium is pretty slim. With a one-year CD you get a 0.25 percentage point premium over liquid accounts and can reinvest at higher rates a year down the road."

Obviously, no one is going to get rich on current rates. At 2.3%, it will take 31 years to double your money, and interest from CDs and money market funds are taxable at your clients' maximum tax rate. On the other hand, earning 1% is better than earning nothing. A client with $100,000 in cash could now get $1,200 to $2,300 income from money funds or bank CDs. That's better than zero, and worth at least a few nice dinners out.

And a 2.3% yield from a five-year CD is higher than the average stock yield in the Standard & Poor's 500 stock index. While that's probably not enough to tempt most stock investors, who are looking for price appreciation and yield, rising rates could start to offer competition for investors' money if rates continue to rise, as expected.

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