The best money-market funds: Take advantage of historically high interest rates

Today, money-market funds are the answer to the question of where to put your money that is safe—and that also gives investors yields in the vicinity of 4% to 5% yearly. That’s a lot richer than bank savings accounts, which remain historically stingy, usually well below 1%. Money funds, largely sponsored by such financial giants as Fidelity Investments and Charles Schwab, invest in short-term, low-risk debt. They don’t appreciate in value, as stock and bond funds do, or should do. Peace of mind and not-bad yields are your rewards.

The turnaround in money funds’ fortunes is remarkable. They are suddenly in vogue because, after years of microscopic rates, the Federal Reserve in March 2022 began to march them higher to combat inflation. Investment inflow into the funds picked up, then accelerated further this spring as they became a refuge destination. With the failure of Silicon Valley Bank and Signature Bank and the resulting turbulence throughout the regional banking sector, investors sought sanctuary.

U.S. money funds reached a record $5.25 trillion as of April 5, according to the Investment Company Institute. “There’s an avalanche of money going out of banks and into money-market funds,” says Brian Frank, chief investment officer of Frank Capital Partners in Key Biscayne, Fla. “You get 4% or more of relatively risk-free yields.”

And guess what? Rates are likely to increase even more. “Going forward with the ongoing risk of inflation, a strong housing market, and future policy changes by the Fed, interest rates are expected to move higher,” says Judith Raneri, a money fund portfolio manager at Gabelli Funds, based in Rye, N.Y. Although many strategists expect the Fed is near the peak of its hiking regimen, odds are that rates will stay at that level for some time, meaning continued attractive returns for fund holders.

Anatomy of a haven investment

U.S. money funds’ assets have ballooned two-thirds over the past 10 years, with much of the growth occurring recently. Chock-full of highly liquid securities—Treasuries and other investment-grade–rated debt obligations, whose maturities are often for a year or less—these funds are the epitome of stability.

In many cases, investors can treat them like bank checking accounts and write checks on them. Removing money typically is easy and doesn’t involve withdrawal fees. The funds pledge to maintain a constant NAV, or net asset value (a fund’s assets minus its liabilities, divided by the number of outstanding shares), of $1 per share.

Money funds have an advantage over banks, which generally pay much lower interest, with savings accounts generating a measly fraction of a percent. The big plus for banks is that they are covered by the Federal Deposit Insurance Corporation, for deposits up to $250,000. Money-market funds don’t have that extra layer of safety, although you could argue that the funds’ assets are so solid that Uncle Sam’s sheltering arms aren’t needed.

Take note, though: Banks offer what they call “money-market accounts,” a product that also enjoys FDIC protection. Some people confuse these with money-market mutual funds, which are generally the offspring of Vanguard Group and its fund industry kin. The bank versions mostly fall way short of the yields that money funds produce.

The best that banks can pay you nowadays (with a few exceptions, namely online banks that don’t need to underwrite costly branches) are their certificates of deposit, which lock up your money for a given period, yet pay a full percentage point or less than money funds. JPMorgan Chase, the nation’s largest bank, offers customers a one-year CD of $9,999 that carries a 3.0% annual rate. Alas, if you want to cash in the CD early, then you forfeit 180 days of interest, albeit not more than the total amount you’ve already earned.

What could go wrong with money funds? If Congress fails to raise the debt ceiling, then the possibility looms of a default on Treasuries, a trauma that would send their prices skidding—a body blow to investors, not to mention vendors who aren’t paid and Social Security recipients who see part of their expected income vanish.

In fact, the rare blowup for money funds centered on what was the original money fund, launched in 1970. The Reserve Primary Fund foundered during the 2008 financial crisis as commercial paper fell hard. The fund “broke the buck,” meaning its NAV fell below the hallowed $1 per share NAV. One semi-comforting thought: The U.S. Treasury Department rode to the rescue and guaranteed the fund’s share price, along with other ones that were teetering. As we saw with the Washington backstop in the recent bank crisis, the government seems more than willing to throw out a lifeline.

Which money-market funds yield the most?

If we take the funds’ stability for granted, then the question is, Which ones pay investors the most?

There are four main kinds of money-market offerings: Treasury funds (which invest in U.S. Treasury bonds); government funds (Treasuries, bonds of government-sponsored enterprises like Fannie Mae, and overnight repurchase agreements for government securities, a.k.a. repos); municipal funds (tax-exempt bonds from local and state governments); and prime funds (short-term corporate debt, notably commercial paper, with some non-Treasury government bonds).

As they don’t require legions of analysts to search for good buys, as actively managed stock funds do, money funds don’t carry heavy expenses. In 2022, the expense ratio, defined as the doing-business costs divided by assets, was just 0.13%, a fourth of stocks funds and a third of bond funds. Further, money funds are yielding between what stock and bond funds are returning. Money funds this year are yielding 4.7% on average, compared with the 7.2% total return (appreciation and dividends) for the S&P 500 stock index and 3.4% for the Bloomberg Agg bond index. “They’re competitive, with low expenses,” says Will Stark, managing director of private wealth services at Howard Capital Management in Roswell, Ga.

In yield terms, these money fund categories are not too far from one another, but they do furnish differing portfolios with disparate risk profiles. By the reckoning of Crane Data, the average yield for prime funds is the largest, at 4.7%. That makes sense because commercial paper, while hardly far out on the risk curve, lacks the assurance that Treasury bonds boast.

Government and Treasury funds, sitting squarely in the federal camp, are perceived to have lower risk. Their average yields are 4.25% and 4.23%, respectively. Funds for municipal debt, known as munis, are tax-exempt, a situation that allows them to pay less than the others, an average 3.59%. Investors, however, get the benefit from avoiding taxes. For someone in the 32% tax bracket, that translates to what’s called a tax-equivalent yield, of 5.3%, on the high end of the money fund yield scale.

While Crane doesn’t break out individual municipal high-yielders, one well-known standout is Fidelity Municipal Money Market (FTEXX), Howard’s Stark says. Yield: 3.8%, or 5.6% tax equivalent. On Crane’s list for the top-yielding government money fund is Vanguard Federal Money Market (VMFXX), at 4.75%. For Treasury funds, it’s Vanguard Treasury Money Market (VUSXX), 4.7%. And prime funds: JPMorgan Liquid Assets Money Market (CJLXX), sponsored by the bank’s asset management arm, 4.98%.

An enemy of interest-paying investments is inflation, which eats away at income, but that appears to be declining. The most recent personal consumption expenditures price index, the Fed’s favorite inflation gauge, rose 5% from a year earlier, and this is down from 5.3% the month before. That is not too far from what money funds now are paying.

Should the long-predicted recession finally arrive, the one bright spot in an ocean of misery would be that stocks decline. And those with hefty money fund accounts can pick up shares on the cheap, noted asset manager Frank. Meanwhile, in the money funds, they’ve been paid decently.