New SEC rules offer an opportunity for advisors and their clients to reassess their strategies around liquid cash.

Major changes are on the horizon for money market funds. Following the 2008 Financial Crisis and the pandemic-induced stock market plunge in March 2020, the U.S. Securities and Exchange Community adopted new rules designed to discourage massive outflows and prevent future instability.

Under new regulations announced on July 12, 2023, money market funds—which are short-term-oriented pooled investment vehicles—will be required to keep at least 25% of their funds invested in assets with daily liquidity, and 50% of their assets must be kept in securities that are liquid on a weekly basis. Moreover, holders of institutional prime and tax-exempt money market funds will pay mandatory fees when a fund is forced to pay out daily redemptions that exceed 5% of fund assets. This essentially means that when the next period of market volatility arises, client returns could be significantly impacted.

Advisors have long considered money market funds as a safe place to transfer client assets prior to deciding where to invest longer term, or for storing emergency cash reserves. But these new rules may change that calculus, and advisors would be smart to further scrutinize money market funds before allocating client cash to these vehicles.

What do these new rules mean for clients? Here are five reasons why now is a good time to rethink money market funds and consider instead helping your clients move their cash into high-yielding FDIC-insured savings accounts:  

1. Liquidity rules may drive down yields. The new regulations around liquidity will force fund managers to migrate fund holdings to more liquid investments. Part of how money market funds deliver high yield is by taking duration risk by purchasing longer-dated securities, so a regulatory mandate to curtail this activity can be expected to drive down returns.

2. Clients are at risk of paying added fees. With the rule change, certain money market funds with 5% or more daily redemptions must impose liquidity fees, meaning the remaining investors in a fund will have to bear the burden of those added costs, further diminishing returns.

3. Money market accounts are not FDIC-insured. Many investors mistakenly believe that money market funds are insured by the Federal Deposit Insurance Corporation. They’re not. In fact, during the financial crisis, the Reserve Primary Fund “broke the buck,” meaning clients didn’t get back 100 cents on the dollar. Ironically, investors in money market funds often earn less than they could simply by keeping their cash in FDIC-insured bank accounts. In short, by purchasing money market funds, clients are often taking on more risk and earning less return.

4. Beware of brokered deposits. Because the FDIC only guarantees up to $250,000 per depositor, per account type, per bank charter, depositors must be vigilant about staying within these limits. Many banks and brokerage firms offer a service known as cash sweeps, which route client cash to an intermediary that in turn spreads cash across a network of other banks. But this service can be risky, as assets are held in omnibus accounts and are not custodied directly in the depositor’s name. If the originating institution brokering the deposits were to fail, clients could temporarily lose access to all their savings. Moreover, if clients already hold deposits at another bank, they may unknowingly exceed FDIC limits. It’s smarter (and safer) for clients to hold cash directly in their own names in their own accounts at multiple FDIC-insured banks.

5. Clients can avoid needless risk by opening high-yield savings accounts. Instead of investing in money market funds, clients can often earn a higher yield that is also FDIC-insured by opening high-yield savings accounts. Some online banks are currently paying rates above 5%, which are FDIC-insured if depositors keep deposits below applicable limits. These accounts are also more liquid, titled directly in the client’s own name, with the ability to withdraw funds the same day. Services like MaxMyInterest can help clients parcel out their cash across multiple bank accounts held directly in the client’s own name.  In doing so, clients can increase their FDIC insurance coverage while earning market-beating yields of up to 5.30%, without the risks inherent to brokered deposits.

When advisors build portfolios for their clients, they must balance risk with reward. Clients who have a higher appetite for risk stand to earn potentially higher returns. But money market funds upend the traditional risk-reward continuum, as investors are essentially assuming higher risks while settling for lower returns. Why would you take on the risks of a money market fund—however small—when there are safer, more liquid, and higher-yielding options available for clients?

The new SEC rules offer an opportunity for advisors and their clients to reassess their strategies around liquid cash. Most advisors will find that clients are better served by spreading their money across a network of high-yield savings accounts that are insured by the full faith and credit of the U.S. government. 

Gary Zimmerman is CEO of MaxMyInterest, a service that offers cash management solutions for financial advisors and their clients. For more information about Max, please visit www.MaxForAdvisors.com.

 

(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.