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When money market interest rates broke above 5 percent last year, it was a wake-up call for many investors who had grown accustomed to getting almost nothing for their money at banks.
Hundreds of billions of dollars flowed into the funds, which swelled in size month after month. Now that the Federal Reserve has begun cutting short-term interest rates — and money market funds have begun reducing their rates, too — you may expect that these funds would be less appealing.
But nothing could be further from the truth. The “wall of cash” in money market funds isn’t flowing into the stock market or other risky investments. It is, for the most part, staying where it is — and growing larger.
In fact, cash in money market funds has hit new peaks since Sept. 18, when the Fed reduced its benchmark federal funds rate by half a percentage point to a range of 4.75 to 5 percent. Meanwhile, rates for the biggest money funds tracked by Crane Data, an independent financial market research firm, have dropped to 4.68 percent from 5.06 percent. But $159.2 billion flowed into money funds overall through Oct. 17 — putting their total assets at $6.794 trillion.
That’s good news, as I see it. It means that the vast majority of investors are keeping their cash in safe, high-paying locations — getting far better yields than most bank accounts offer, and avoiding excessive risk-taking with money that they presumably can’t afford to lose in speculative bets. What’s more, if rates fall further, money market funds are likely to retain a comparative advantage for months to come, pulling in cash because they continue to look better than the alternatives.
Why Use Them
The funds are popular because they are a fine spot for parking short-term cash. Your money is available whenever you want it, no strings attached. And the best low-cost money market funds are still providing a decent real return: more than 2 percent, after inflation.
This hasn’t always been the case. It certainly wasn’t true while the Fed held short-term rates near zero — a punishingly low level that was in place most of the time from the autumn of 2008 through the spring of 2022. Those rates deterred many people, including me, from bothering with money market funds at all. Why take your money out of a bank account, which is insured by the Federal Deposit Insurance Corporation, to put it into a fund that isn’t government insured and isn’t paying you much of anything?
A heightened desire for safety in money market funds was one of the legacies of the 2008 financial crisis. There have been only two known incidents when money market funds couldn’t pay 100 cents on each dollar in them — they “broke the buck,” in Wall Street jargon — and one occurred in 2008. But no significant losses occurred in either case. This month, tighter government regulations aimed at increasing the funds’ security took effect.
Still, when inflation began to take off in 2021 and 2022, I remembered how great money market funds were during an earlier burst of rising prices. They were a haven for ordinary people in the late 1970s and 1980s, when the funds started to come into vogue. Back then, corporations, consumers and canny investors were all frantically looking for ways of holding on to the value of their cash, which was shrinking rapidly.
So in early June 2022, when money market rates were below 1 percent yet inflation was above 8.6 percent and rising, I realized that money market funds were about to become hot again. The Fed was raising interest rates to squelch inflation, and by early last year, short-term interest rates exceeded the annual rate of the Consumer Price Index. Money market rates have paid a positive real return ever since.
Now, though, headlines are proclaiming that many interest rates are dropping. The Fed deems inflation sufficiently tame to be lowering short-term rates, and the fabulous yields of money market funds have probably peaked.
Even so, the substantial appeal of money market funds remains in place: Their rates are still positive in real terms, and they continue to compare favorably with most rates offered by banks, which have been dropping, too.
While it’s true that certificates of deposit at some banks offer competitive rates, they require that you lock up your money for a specified period or incur penalties. At the moment, short-term money market rates are higher than those of longer duration in the bond market: That’s the meaning of the statement that “the yield curve is inverted,” which is often repeated in financial coverage. As a result, you are unlikely to get as much interest from C.D.s or Treasury notes as you can now get in money market funds.
That will change eventually because most of the time, investors expect to be paid more when they lock up their money for longer periods. But it hasn’t happened yet, and the lure of money market funds is likely to last a while longer.
Not Big Moneymakers
Despite their advantages right now, money market funds haven’t been a good investment over the long haul. Actually, I’m not sure they are an investment at all.
Morningstar, a financial services company, ran the numbers for me. Here are the annualized returns for several important U.S. asset classes, as well as for inflation, from 1926 through 2023:
Large stocks, like those in the S&P 500, 10.3 percent.
Small stocks, 11.8 percent.
Treasury bonds, 5.1 percent.
Treasury bills (a proxy for money market funds), 3.3 percent.
Inflation, 2.9 percent.
In short, over long stretches, money market funds have barely kept up with inflation. If you can afford to take some risks with your money, start with bonds and then move to stocks, which have provided better long-term returns but often experience losses. Money market funds (and Treasury bills) are in another category entirely and aren’t interchangeable with stocks.
No Flood Into Stocks
It’s often assumed that when the Fed lowers rates, people will pull cash out of money market funds and pour it into the stock market.
There’s scant evidence that this has happened, however, now or in the past.
“It’s not until rates fall below 3 percent that people start to pull money out of money market funds,” Peter G. Crane, a founder of Crane Data, said in an interview. “I don’t see that happening soon. And I don’t see any big movement from money market funds into the stock market.”
The Federal Reserve tracks money fund flows from institutions — corporations that use the funds for paying short-term expenses or as a holding facility in between stock and bond market trades. Using these records, Mr. Crane found that since 1990, whenever the Fed has lowered interest rates, cash has rapidly flowed into money funds — far more rapidly than when the Fed has either raised rates or left them unchanged. That may be because banks tend to lower their already paltry savings rates more rapidly than money market funds do — making the funds more attractive on a relative basis.
Short-term interest rates are heading lower, the Fed says, and most economists agree. But how rapidly depends on inflation and the job market, which are affected by many factors outside the Fed’s control, including domestic budget deficits, war and politics. At the moment, the Fed is moving slowly. The federal funds rate, the central bank’s main policy rate, isn’t likely to pierce the 3 percent level until 2026, according to the Fed’s projections. I don't know how long it will take, but it’s probably not happening soon.
So money market funds remain extremely competitive, given the alternatives. Where else am I going to put my short-term cash? Certainly not the stock market, where a sharp downturn could put me in a bad predicament when I really need the money to pay the bills.
Don’t get me wrong. I’m a long-term investor, using index funds that track the world’s stock and bond markets, and I’m prepared to take short-term losses. My intention is to keep those holdings for many years and ride out market declines.
But that’s only for long-term holdings. For my ready cash, I use money market funds and expect to do so until the funds stop paying a reasonable interest rate. Eventually, when yields have dropped sharply, I’ll shift this money to a government-insured bank account where it will be safe, not to the stock market.
But the time for that migration hasn’t come yet. Right now, for ease, safety and a modest but reasonable return, high-quality money market funds still look all right to me.
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