Why advisors should ditch money market funds

(Originally published in Bond Buyer December 1, 2020)

Money market funds (MMFs) have long been a staple in brokerage accounts as a safe place to stash cash that’s not being invested. In light of the events of the past year, it’s time financial advisors and their clients re-examine this approach.

Historically, MMFs have been used to provide safety, liquidity, and yield. In today’s market, these funds now fall short on multiple fronts. The onset of the Federal Reserve’s zero interest rate policy has eroded the value proposition of MMFs considerably, to the point where several trillion dollars of MMFs are no longer an attractive option for individual investors.

To understand why, we must first examine the origins of MMFs. The idea was remarkably simple: help clients obtain a higher yield than bank accounts by buying short-term government securities. Pooled together, there were sufficient funds to actively trade in and out of these securities, picking up yield by taking slightly longer duration and a little bit more risk. With enough scale, a fund manager could be paid circa 0.15% in fees to select, buy, and sell these bonds, and investors could pick up higher yield through an instrument that looked pretty safe, given that the underlying securities were government bonds and other short-term paper. As long as all investors didn’t run for the exits at the same time, clients would be able to access funds the next-day, while earning yield that was higher than that offered by a brick-and-mortar bank account.

Of course, there’s rarely a free lunch in finance. This became painfully apparent during the financial crisis when the Reserve Primary Fund broke the buck. When investors sought liquidity from this MMF at the same time, the underlying securities had to be sold at a discount and investors lost principal when they couldn’t get back 100 cents on the dollar. While there have been few such failures of MMFs relative to the trillions of dollars in these funds over the past few decades, taking on the risk of any loss of principal only makes sense if you’re able to pick up additional yield that justifies it. Today, that risk-reward equation doesn’t hold, since MMFs yield substantially less than FDIC-insured online savings accounts.

Many Fed watchers expect the current near-zero rate environment – which has driven down MMF yields – will persist for several years. One need only look at the yield curve to conclude that low-interest rates will be with us for a while. The recovery of our economy – and thus, rate policy – will depend significantly on the course of the pandemic.

The most prominent government MMFs yield only five basis points (0.05%), and while prime funds may yield slightly more, they also carry more risk. Under the Securities and Exchange Commission’s new rules promulgated following the financial crisis, retail-held prime funds can be subject to 10-day redemption gates and redemption penalties of 1-2% in periods of financial stress, making it potentially even harder to access cash when needed. For clients seeking safety, liquidity and yield there are far better options than MMFs.

What’s a much simpler solution for keeping client cash safe? Plain vanilla FDIC-insured savings accounts. Today’s leading online banks – which are able to pay higher yield by eschewing brick-and-mortar branches – are delivering yields of 0.40% to 0.60%. Through platforms like MaxMyInterest, some are even able to pay rates as high as 0.85% — a full 80 basis point premium over a government money market fund. With the funds sitting in FDIC-insured and same-day liquid accounts, this incremental yield comes with greater safety and liquidity as compared to an MMF.

Sadly, institutional investors can’t easily benefit from FDIC insurance coverage in scale and so will remain beholden to MMFs for the time being. But, for retail investors who hold six-to-seven figures in cash, FDIC-insured bank accounts can deliver dramatically higher yield than money market funds.

Given the recent economic challenges and market volatility, financial advisors are looking for safer, higher-yielding options for their clients’ cash – and are turning to one that was previously overlooked: online saving accounts. Advisors would be smart to take note of advisor-oriented solutions that can help clients maintain a cash cushion during times of financial stress while earning higher yield along the way.

Take a look at your clients’ brokerage statements. If they’re sitting in MMFs or earning 0.01% on a broker’s cash sweep, it may be time to reevaluate your strategy for cash. Your clients will thank you.

What’s Better for Clients Than Money Markets? Max.

This week, Max is at the T3 conference in Orange County, Ca., which is spurring us to think about financial advisors and how we can help them best serve their clients.

As financial advisors think about where to put their clients’ cash, many head automatically toward money market funds. But in today’s regulatory environment, where money market funds pay ultra-low rates and can force investors to pay redemption penalties in times of market turmoil, they may no longer be the best choice.

There is a better solution for cash held in brokerage or bank accounts. It’s called Max.  

Some statistics about cash: high-net-worth households in the U.S. are currently holding 23.7% of their assets in cash. That works out to a staggering $3.5 trillion, just among the top 4% of the U.S. population.

Most of this cash is being kept in the wrong place. In money market funds, it is under-earning its potential and it’s not insured.

Clients hold cash for a host of reasons, including as a reserve for a future real estate purchase, private equity capital call, or other asset buy. A recent U.S. Trust survey showed that a majority of clients were holding cash on the sidelines to serve as “dry powder” to capitalize on market opportunities. That’s the same reason why Warren Buffett has said he likes cash so much.

Most financial advisors think that clients aren’t holding much cash because what they see is the cash allocation within the client’s investment portfolio. The reality is that there’s a lot more cash sitting on the sidelines, out of view of the advisor. Most high net worth investors maintain multiple advisory relationships at several institutions. Advisors’ wallet share is only what clients choose to bring to them.

Where is this cash being held? Up until this point, the default for many financial advisors was to keep client cash in a money market fund. This is no longer best practice, especially in a fiduciary environment. It’s difficult to justify offering your clients less of a yield on uninsured cash when there’s a solution that allows them to earn more and stay FDIC-insured.

After the 2008 financial crisis, the SEC imposed new rules on money market funds, rendering them no longer a true cash equivalent. Under the new regulations, retail-held prime funds are subject to redemption gates of up to 10 days and redemption penalties of 1-2% in periods of financial stress. This means that your clients may not be able to access their funds when they need them most. At the same time, yields on money markets are still relatively low, and these funds are not insured.

How can Max solve these problems? Max offers a tool that lets advisors bring more cash into view, help clients earn more on that cash, and help ensure that cash is fully insured. We’ve created a better solution for cash, offering liquidity, higher yield, and greater FDIC insurance. Max doesn’t take custody of clients’ funds. Their cash stays in the client’s own name, while our software acts as a sort of air traffic control system, telling the banks to move funds among the client’s own accounts whenever it’s advantageous to do so to get better rates. In this manner, clients continuously earn the highest yield possible within the FDIC limits. That means Max members can keep up to $5 million per couple insured, and we have a partner solution that can deliver up to $50 million of FDIC coverage per tax ID for business accounts or complex trusts.

Now that money markets are considerably less attractive, isn’t it time to find a better way to manage cash? Learn more about Max at MaxForAdvisors.com.

Fiduciary Solutions for Financial Advisors: How to Think About Clients’ Cash

Max members are earning about 10 times more on their cash than the national average.

Max members are earning about 10 times more on their cash than the national average.

With the move towards the fiduciary standard across the investment-management landscape, financial advisors increasingly are looking at how they can make sure their clients are getting this standard of advice for the cash portion of their portfolios as well as for their securities. That’s where Max comes in. 

Cash is the one asset class that’s present in every portfolio. But a near-zero-interest-rate environment over the last few years has meant that investors overwhelmingly are earning almost nothing on cash. The national average on savings accounts is 11 basis points — 0.11%. As a fiduciary, an advisor is bound to give advice that’s in a client’s best interest financially. For cash, this means advisors have to seek out ways that clients can earn more interest while remaining insured under the FDIC deposit guarantees.

– Think carefully before using money market funds

Money market funds are a traditional substitute for cash, because they’re designed always to trade at a stable $1 per share. But with new regulations, these funds may now be able to hold onto investors’ money if markets are in turmoil. That means that clients may not be able to get their money out of a money market fund when they need it most. With this lower level of safety, and essentially no yield, money market funds may not be up to the fiduciary standard as a cash equivalent.  

– Use online banks

Online banks don’t have branches, so their cost structure is considerably less than their brick-and-mortar competitors. This imbalance allows them to offer higher interest rates to depositors — above 1%, in some cases, making online banks the highest-yielding places to park cash that clients wish to keep fully liquid. FDIC-insured online banks have the same federal deposit guarantee as any other U.S. bank protected under the program.

– Seek more FDIC coverage

Many investors don’t realize that exceeding the FDIC limits in their accounts means that excess money may not be safe if something happens to the bank. If your clients hold more cash than the FDIC limit — $250,000 per depositor, per account type, per institution — you should consider helping them open accounts at additional banks to gain FDIC coverage for as much of their cash as possible. Keeping cash safe is a prerequisite for fiduciaries.

– How Max can help

It’s possible to get both higher interest on cash and greater FDIC coverage. That’s what Max provides for advisors and their clients through the Max Advisor Dashboard. The average Max client is currently earning more than 1.00% on cash and enjoying FDIC coverage across several institutions. Learn more about how you and your clients can benefit at MaxForAdvisors.com.