Money for nothing: Reality of near-zero interest rates

For a safe place to keep your cash, people can consider government money market funds.

Jul 12, 2020

Jeff Sommer


Having enough cash on hand to pay the bills is always a good idea. But in an economic crisis like this one, with millions of people unemployed and thousands of businesses in trouble, it's more desirable than ever.

Plenty of people don't have a stash of cash. But for those fortunate enough to have stashed away some extra money, a pressing question is: Where should you keep it?

The standard answer is somewhere safe, like a bank or a money market fund.

But don't expect much in return. Now that the Federal Reserve has committed to keeping short-term interest rates near zero until at least 2022, you are likely to earn almost nothing on that money. And that's if everything goes according to plan.

I'm not talking about a long-term investment; a diversified portfolio containing low-cost index funds that track broad markets would be my own preference for that. This is about a cash reserve for use over, say, the next three to six months, if life becomes cruel or you need to make a big payment for tuition or a car repair.

"Investors like to say 'cash is king'," said Mr Peter Crane, president of Crane Data which monitors money market funds.

"In the coronavirus crisis, I'd say, cash is bigger than that; it's the emperor of all things. If you ever doubted whether you needed some emergency savings, you probably believe it now."

I spoke with Mr Crane a decade ago, in the aftermath of the global financial crisis of 2007 to 2008, about the extraordinarily low yields on money market funds. Those rock-bottom, near-zero rates were expected to be temporary but they lasted for years.

Now, he said: "We're right back where we were then. The economy is in trouble, the Fed has responded and money market funds are paying almost nothing." What's more, many fund companies are already waiving fees. If they didn't, money market yields would be plunging below zero - in effect, into negative territory.

In that event, investors would be paying fund companies for the privilege of holding their money, an absurdity that major mutual funds generally want to avoid.

"That wouldn't be attractive to investors, to say the least," said Mr Joseph Lynagh, head of cash management at T. Rowe Price, a big asset management company.

Using the T. Rowe government money fund as an example, he walked me through the company's thinking. The fund's current expenses, including administrative and management fees, add up to 0.42 per cent of total assets, a figure that you can find on the company's website.

But the fund's current gross yield - the income from its investments - was only 0.31 per cent.

"You can infer from that, that without the fee waiver, the fund yield would be negative 0.11 per cent," he said. In other words, you would give T. Rowe Price US$1 and one year later, you would have a small fraction of a cent less. That's not terrible but it's not a winning proposition.

And, he added, the gap between the T. Rowe fund's income and its expenses is likely to widen the longer this economic crisis continues. That's because money market fund managers must continually purchase new securities, and these will be paying lower rates than securities purchased before the downturn became acute.

Deep-pocketed companies like T. Rowe Price, Vanguard, Fidelity, BlackRock and others are playing a long game. "Even if they are technically entitled to charge investors - or recoup waived fees later - they generally don't want to do it," he said. "It would hurt their reputation too much." That doesn't mean that they wouldn't do it.

He added that he would stay away from funds with the very highest yields. "Higher yield probably means higher risk," he said.

For a safe place to keep your cash, he suggested that you consider government money market funds which, as the name implies, hold government securities. "Prime funds", which can hold commercial securities, may be less liquid when the going gets rough.

But prime funds are a reasonable choice too. They have been quite safe compared with mutual funds that hold stocks or bonds and often lose large amounts of money. Even in the worst case of the last 20 years, in which one fund lost money for investors, the losses amounted in the end to only 1 cent on the dollar.

For even greater security, consider a bank account with Federal Deposit Insurance Corp (FDIC) backing. Accounts from old-fashioned banks with bricks-and-mortar branches, as well as higher-yielding online-only enterprises, carry FDIC insurance.

In periods of extremely low market interest rates, like this one, some online bank accounts have higher rates than money market funds do, reversing the typical relationship. The banks' advantage may not last, but as long as the accounts are fully insured, there's little risk in exploiting it.

NYTIMES