June 13, 2003

Money Market Funds Face Expense Crunch

An excerpt from the June 13, 2003, edition of The

Reserve Primary Fund (RFIXX) boasts an impressive pedigree as the very first money-market mutual fund, opened in 1971.

But the $6.3-billion portfolio also holds another less-appealing distinction among money funds: despite its multi-billion dollar heft, Reserve Primary Fund charges annual expenses that are considerably above average -- 1% of assets versus an average 0.73% for retail money funds tracked by iMoneyNet Inc.

These days, more than ever, investors in money funds, which hold $2.2-trillion in assets, need to be scrutinizing such charges. Short-term interest rates are at their lowest levels in more than four decades, their lowest since money funds were created. Furthermore, market participants expect the Federal Reserve to cut interest rates further later this month in a bid to stimulate the economy.

For investors, the net result of the record-low rates is that expenses as a percentage of money funds' portfolio earnings "are much higher than they have ever been," says Bob Auwaerter, head of fixed-income portfolio management at Vanguard Group.

Indeed, variations in money-fund expenses can mean the difference between a tiny yield and virtually no yield at all. Some smaller money funds with high expenses have seen their operating costs eat up essentially all their earnings, leaving investors with yields in the hundredths of 1%. A number of firms are waiving some of their normal fees to keep money-fund returns from turning negative.

Even without another round of rate-cutting by the Fed, a number of multi-billion-dollar funds are scraping bottom in terms of the returns they pay investors. As of Tuesday, for instance, Reserve Primary Fund has a yield of just 0.29%. As of that same date, the average retail money fund tracked by iMoneyNet yielded 0.51% and giant low-cost funds offered by Vanguard and Fidelity Investments were yielding above 0.90%.

Given today's tiny money-fund yields, investors should be reviewing the role these accounts play in their financial affairs. For most investors, "yield isn't the most important reason to be in money funds. It may be a distant third to safety and liquidity," says Peter Crane, a vice president and managing editor at iMoneyNet in Westborough, Mass. Money funds are a logical parking place for a family's emergency reserves and any additional money that will be spent within the next year or so, many financial advisers say.

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