Should You Buy a Money Market Fund?
It’s a rare there’s an investment that’s almost guaranteed to lose money but it does seem to exist. It’s called a money market mutual fund.
Unlike other things in life where you’re pretty much destined to lose (lotteries come to mind), the money market mutual fund is surprisingly bland. There are no vague promises of great winnings to be had.
No, with these funds, it’s death by a thousand cuts, at least so long as you stay in them.
So what are they?
It’s a very simple concept. Entities such as governments and large corporations are always borrowing money on a short-term basis. Funds are lent to these borrowers in return for a small rate of interest.
Much like an equity mutual fund pools different investors’ savings to buy stocks, a money market fund pools investors’ savings to buy this short-term debt.
Low returns
As everyone knows, we’re currently living in a low-interest rate environment. That’s made it advantageous to be a borrower of money but difficult to be a saver.
Nowhere is this truer than with money market funds. Consider one of the larger Canadian funds, the TD Canadian Money Market Fund. With more than $1.5 billion in assets, the one-year return on this fund was a paltry 0.17%.
We don’t mean to pick on TD (because this is an industry-wide issue), but it gets worse. This particular fund has a management expense ratio (MER) of 0.69%. What this means is that for every $100 you invest, the fund charges $0.69 as a management fee. In other words, the MER is wiping out most of your returns.
And you’re losing out because you’re suffering what economists call an opportunity cost. That is, the lost benefit of having done something else.
What else could you do with your money? Two things spring to mind: You could purchase a GIC or open a high-interest savings account.
With either choice, you could easily get a return of 1% or more on your money. And that’s without having to pay any hefty management fees.
Believe it or not, money market funds are costing investors millions of dollars. According to GetSmarterAboutMoney.ca, a website operated by the Ontario Securities Commission, Canadians forego $300 million to $500 million annually in interest income they could have earned had they switched from money market mutual funds to higher-interest bearing investments.
What’s more, as MoneySense points out, money market funds aren’t even covered by government deposit insurance. Not only are you getting an incredibly small, if negative return on your money, your investment isn’t guaranteed by third-party insurance.
A counter argument to all of this is that money market funds aren’t designed for long-term investing. Just as the borrowers do so on a short-term basis, so too the investors are really only parking their funds temporarily until something better comes along. If you want your money to sit somewhere, be it for three months, six months or a year, you might as well reach for the highest return.
Finally, remember that ultra-low interest rates combined with inflation are a toxic combination to your money’s purchasing power. Even assuming you made 0.3% after management fees with a money market fund, that’ll pale in comparison to consumer price inflation of roughly 2%. That’s a loss, in inflation-adjusted terms, of 1.7%.
There are things in life to be a fan of (the Toronto Raptors come to mind). But you probably shouldn’t be a fan of money market funds.
Also read:
- Should You Buy a High-interest ETF?
- 5 Reasons to Have a High-interest Savings Account
- What’s the Best Savings Option for Parking Your Money?
Flickr: KMR Photography