Kiss Those Big Fat Yields Goodbye

Investors are somewhat relieved after last month's Fed cut in the discount rate. They know that the Fed's got their back, willing to cut rates if the economy begins to buckle as long as inflation fails to see its shadow. Money market savers aren't as lucky. Lower interest rates ultimately translate into lower yields on interest-bearing accounts.

No, the party isn't over, but make sure you grab a goodie bag on the way out after the pinata gets whacked dry.

"I am currently considering placing some cash into a money market fund as I know I could get more out of my money versus keeping it in a savings account at the local bank," someone wrote on a discussion board for Motley Fool Green Light subscribers two weeks ago. He was considering the Vanguard Prime Money Market (FUND: VMMXX), a popular choice with $84 billion in assets and one of the industry's best current yields at 5.11%.

"What would happen if the Fed did decide to cut rates?" he asked.

Like most money market funds, Vanguard invests in short-term income-producing securities. The average maturity in Vanguard's fund is a mere 46 days. Money market funds keep maturities short to protect the net asset value (NAV) standard of $1.00. (A mutual fund's NAV is the amount of money that an investor would receive for each share if the mutual fund sold all of its assets, paid off all of its debts, and distributed the proceeds to shareholders.)

If rates fall, bond coupons and money market yields are likely to follow.

It may not seem that way at the moment. Everywhere you go, companies are clinging to stay above that attractive 5% mark. E*Trade (Nasdaq: ETFC) is offering a 5.05% yield on its Complete Savings Account. eBay's (Nasdaq: EBAY) PayPal is encouraging accountholders to keep a balance by paying them 5.04% on their money.

However, let history be your guide. Funds aren't charities. They can trim expense ratios and occasionally waive them completely for promotional purposes, but they ultimately have to play along to the market's tune.

Let's take a look at how the Vanguard fund has performed over the years.

 

	Yield
2006	4.88%
2005	3.01%
2004	1.11%
2003	0.90%

Yields bottomed out early in 2004, when the Fed began to orchestrate a series of small yet deliberate rate hikes. Economists don't expect the lows to be revisited for now, though money market fans shouldn't feel entitled to fat yields forever.

Where were those goodie bags, again?

 

© 2007 Universal Press Syndicate.