Five Reasons to Rethink Money Market Funds

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

Portions originally published in WealthManagement.com on August 17, 2023

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.

 

The Mistake Nearly Everyone Is Making With Their Cash

Portions originally published in ThinkAdvisor on April 18, 2023

In the weeks since the sudden collapse of Silicon Valley Bank, other banks, brokers and fintechs have scrambled to roll out increased FDIC insurance solutions to capitalize on the opportunity to attract new deposits. Unfortunately, in the mad rush to roll out something, anything, they are exposing your clients to the very same risks that they should be seeking to avoid.

The collapse of SVB was scary for depositors for two reasons.

First, when a bank fails, any deposits in excess of $250,000 — the Federal Deposit Insurance Corp. limit — leave depositors unsecured, which means they may not get all of their money back.

Second, when a bank fails, even insured deposits can’t be withdrawn until the FDIC takes over the operations of the bank or orchestrates a sale. 

If you think about why clients hold cash, it’s for safety and liquidity. Any solution that puts either safety or liquidity at risk would defeat the purpose of holding cash. That’s why we created MaxMyInterest.com and MaxForAdvisors.com, to create a better, safer, more liquid, and higher-yielding way for clients to manage cash.

The Problem With Sweep Accounts

For decades, banks and brokerage firms have used sweep accounts (known in the industry as brokered deposits) to earn a spread for themselves on client cash. While these solutions are marketed to clients as a means of keeping cash safe by obtaining increased deposit insurance, if you peek under the hood, you’ll find that they expose clients to safety and liquidity risks and are rife with conflicts of interest. 

To identify these risks, it’s first helpful to understand how these sweep programs work. Essentially, an originating institution — could be a bank, brokerage firm, or fintech company — tells you they can provide increased FDIC insurance by spreading (selling) your cash across their network of other banks. That may sound okay on paper, but the reality is that your cash gets swept up into omnibus accounts held in the bank’s name, not in the client’s name. 

This means that if the originating institution were to fail, your clients would lose access to all their funds until the resolution process is complete. In the case of a bank, that may happen in a matter of days, but if a fintech has custody of a client’s funds and they fail, clients may be stuck waiting through a bankruptcy process. Just ask anyone who thought their funds were safe at FTX. 

If a client needed that cash to buy equities when the market dips, too bad. And if they needed the money to make a tax payment or close on the purchase of a house, they may be out of luck, with dire consequences. Clients can’t contact the underlying banks that hold their funds, since they have no relationship with them. 

Furthermore, they don’t know to whom their deposits were sold, and if they happened to be placed with a bank where clients already hold other deposits, they may overlap and exceed the FDIC limits. This means that clients might not be fully insured, even when you thought they were. 

Avoiding Unnecessary Risk

These risks are avoidable. In fact, the main beneficiary of clients taking on these risks is the very institution that is brokering their deposits, since in the process of selling deposits out to other banks, they keep a spread for themselves, passing along a net rate to the customer while hiding the embedded fee or spread that they’re keeping. In short, there’s a conflict of interest that leaves the depositor with less yield and more risk than had they just opened more bank accounts directly in their own name. 

In 2009, in the midst of the Financial Crisis, I identified these risks and began managing my own cash differently, spreading it out across my own accounts held directly at multiple banks, so that I’d have the benefit of increased FDIC insurance coverage while maintaining full visibility, liquidity, and control over my cash, with no single point of failure. When I found that my safer approach had also generated tens of thousands of dollars of incremental yield, I figured that many more people could benefit from this same approach, and we created MaxMyInterest in 2013 to create a new, safer, higher-yielding way to manage cash.

It Pays to Read the Fine Print

Not 48 hours after the collapse of SVB, many advisors, banks and fintechs began repeating the same mistakes of the past. They looked for solutions that purport to keep cash safe without considering the implications of these solutions for safety and liquidity. As a fiduciary, when it comes to your clients’ cash, it pays to read the fine print. By avoiding brokered sweep accounts, you can keep cash safer, more liquid, and earn higher yields at the same time.

The Four Horsemen of the (Financial) Apocalypse

(Portions originally published in RIA Intel, April 6, 2021)

I began my career as an investment banker in 1998. The first dot-com frenzy drove one of the most ebullient markets we’ve seen in recent memory, surpassed only by the two bull markets that have followed since. In between, we’ve lived through some pretty wild corrections and recessions, including the Financial Crisis of 2007-2010 that threatened the global economy and brought to their knees some of the largest banks in the world, including the bank where I worked at the time. And while it may now seem like a distant memory, last year’s flash correction — which stemmed from concern that a rapidly spreading deadly virus might cause financial Armageddon — brought on visceral feelings that were all too familiar.

From market cycle to market cycle, I’ve identified four common themes that seem to presage major corrections. I first noticed these elements in 2001, and at the time dubbed them the “Four Horsemen of the Apocalypse.” The publication last week of a deck of complaints from a handful of analysts at Goldman Sachs brought back to memory these mile markers and got me thinking about where we are in the cycle and what the future might hold.

I share these markers here not to predict a crash. After all, the inflated asset prices we’re seeing across multiple markets could be the result of inflation in nominal prices, not growth in real values. But I’m no expert. I’m neither great prognosticator nor a market timer. In my own portfolio, I’m a strong subscriber to the buy-and-hold strategy: make thoughtful picks (both public and private, macro and micro) and then have the courage (and cash cushion) to stick with them. So timing the market doesn’t matter much to me and my time horizon.

As Mark Twain is reputed to have said, “history doesn’t repeat itself but it does rhyme.” And so I present here for your consideration my “Four Horsemen,” which for me have served as signs of a market that may be heading towards the end of a long bull run.

Analyst Revolt

Last week, a group of 13 intrepid investment banking analysts at Goldman Sachs published a pitch book highlighting their dissatisfaction with the long hours and unending toil of their jobs. From my experience, their observations seemed spot on, although having survived my years as an analyst, I wouldn’t trade that experience for anything. We’ll leave for another column the debate over the fine line between hazing and apprenticeship. What’s notable, though, is that this deck — and the concessions made by banks in the days that followed, including five-to-six figure bonuses and free Peloton bikes — is a sign of the shifting balance of power between capital and labor. When markets become over-heated, workers demand more. In my experience, it’s at precisely that moment that the pendulum swings hard the other way. During the dot-com boom, it was analysts at Salomon Brothers who revolted, requesting toothbrushes and dry cleaning and massages. Less than a year later, Wall Street was beset by mass layoffs. Analysts, be forewarned!

Energy Tech Frenzy

Each boom in software technology seems to be followed closely by a boom in energy technology. Around the turn of the millennium, companies like Plug Power ($PLUG), FuelCell Energy ($FCEL), and Capstone Turbine Corporation ($CPST) were all the rage. Guess which stocks are back?  

Source: Yahoo Finance

There’s an even bigger boom in the works now, though: the excitement caused by the promise of electric vehicles. One industry banker recently pointed out to me that if you sum up the projected vehicle production in the business plans of all the multi-billion-dollar electric automakers (many of whom don’t have a commercial product yet, let alone revenue), you’ll quickly outstrip global auto production. Surely, the auto industry is rapidly heading towards a gasoline-free future, but it can’t be that these new upstarts will take more than 100% market share. 

Armchair Investors

During the dot-com boom and bust, shoe shine guys were sharing stock tips, taxi drivers would talk to me about the condos they were buying and flipping, and firefighters in Staten Island were glued to CNBC’s scrolling stock ticker. Today, we have the GameStop ($GME) mania and dramatic non-fungible token auctions, where at least a portion of the trillions of dollars of government stimulus seem to be looking for a speculative home. When everyday citizens start driving the marginal prices of assets, there’s reasonable cause to be concerned that a correction may be on the horizon.

Miami Condos

It took me a while to remember the last of my four horsemen, since I haven’t been on an airplane in more than a year. It’s a simple measure: are more than 50% of the advertising pages in American Way magazine devoted to sales of south Florida condos? That was the metric that broke the camel’s back in 2007, just prior to the greatest financial crisis we’ve endured since the Great Depression. Speculative real estate purchases drive both increases in debt and all sorts of spending — new cars, home furnishings, art. It’s precisely the sort of debut-fueled spending that can unravel so spectacularly when markets turn south. That’s not to say there aren’t sound reasons to diversify into real estate at a time when the hum of government printing presses makes inflation a logical fear, or when finance jobs are (at least temporarily) moving to warmer and more tax-friendly climes. But the frenzy in the housing markets (it was recently reported that a fixer-upper in the D.C. suburbs received 88 offers, 76 of which were all-cash) might be driven by more than low interest rates. Houses are one of the most leverageable asset classes, a relatively easy way to make a directional bet on the markets, further supported by generous tax benefits. The mortgage market, as chronicled by Michael Lewis in Liar’s Poker, and again later in The Big Short, has become one of the largest asset classes and its demise led to the Financial Crisis.

While no two markets are the same, and there are plenty of reasons to suggest that the current boom can continue, Wall Street is known to “climb a wall of worry,” meaning that you know you’re in a bull market when even bad news doesn’t spook the markets. While a correction may or may not be looming, it’s important not to forget how quickly the tide can turn. It’s for that reason that I’ve made my biggest bet on a $16 trillion dollar asset class that seems to persist amidst bull and bear markets alike: cash.

No matter how risk-loving or risk-averse you are, or where we are in the market cycle, nearly everyone holds cash to some degree. And startlingly, most people still keep that cash in the wrong place, where it earns next-to-nothing. That’s why we developed MaxMyInterest — to help everyone earn more on cash while keeping it safe and sound in their own FDIC-insured bank accounts. Markets will go up, and markets will go down. Knowing that your cash is safe and earning as much as possible can help give you the peace of mind to stay the course with your long-term investment strategy.

How rates will continue to impact cash management in 2021

(Originally published in Bond Buyer February 26, 2021)

The Federal Reserve’s response to the COVID-19 pandemic has pushed interest rates to historic lows over the past year.

Changes to the Fed funds target rate and an extensive bond-buying program have driven down rates both at the short and long end of the yield curve. The 10-year Treasury, with a yield that had hovered around 1%, has led to the lowest mortgage rates in memory. A return of the Fed funds overnight rate to a target range of 0 to 25 basis points — a level not seen since the financial crisis — has caused most banks and brokerage firms to cut the rate they pay on cash to as little as 0.01%.

With the Fed targeting an inflation rate of 2%, and with Chairman Jerome Powell’s stated willingness to let inflation exceed that level for a while to make up for past misses, this effectively means that clients sitting on cash are earning a negative real return. And with the average high net worth household keeping 22.1% of its assets in cash, underearning on this asset class can lead to a material drag on overall real returns.

High net worth households keep 22.1% of their assets in cash. Most are dramatically under-earning on this asset class.

Where are we now?

Historically, financial advisors relied on money market funds to manage idle cash that remains in client portfolios. In the current rate environment, this is no longer a good option for clients. The average government MMF is yielding just 0.02%, so financial advisors who are still using MMFs as a tool for client cash may be relying on outdated advice. Similarly, most brokerage sweeps pay just 0.01%, also not an attractive option. Even the average bank savings account offers a paltry 0.04%, according to the FDIC. Simply put, MMFs and regular savings accounts are no longer delivering a compelling yield. A better solution is needed to keep clients on track.

Broker-dealers aren’t faring much better.

Historically, broker-dealers have made the majority of their profit by putting clients in cash sweep accounts that tend to pay almost nothing, lending out the funds at higher rates, and pocketing the spread for themselves. This little-known fact makes stocks and bonds the red herring of the securities industry — most people assume that brokerages make their money from trading commissions, but, in fact, the majority of their profit is earned from knowingly paying clients too little on their cash.

With yields lower and spreads on cash depressed, they’re still profiting from this practice, but not by nearly as much. It’s possible that a prolonged low-rate environment, coupled with recent penalties from the Securities and Exchange Commission for wealth management firms who haven’t put their clients’ interests first, could lead broker-dealers to re-evaluate whether they ought to make available to their clients better, fiduciary-focused options for cash. After all, cash is the beginning of every wealth management relationship as it is the asset that is safe and liquid — and it is often the case that investment relationships begin when clients determine that they have excess cash that could be better invested for the long-term.

Both monetary and fiscal policy must also be considered.

With the pace at which the U.S. government is printing money, inflation seems all but inevitable. Our national debt has risen by more than 40% in the past four years, and as we begin to recover from the pandemic, inflation could become more apparent in consumer prices.

It is also essential to keep in mind that those who have been fortunate enough to save during the last 12 months are sitting on cash and will be looking to spend or invest it once lockdown protocols ease up. Against that backdrop, cash that’s earning 1 or 2 basis points in a brokerage sweep or MMF is actually losing value each year.

Where do we go from here?

Now would seem to be an opportune time for financial advisors to reconsider how they are talking to their clients about cash.

Many registered investment advisors, who are bound by a fiduciary standard, are beginning to treat cash like any other asset class and are looking to maximize returns for clients.

One of the simplest ways to do this is to turn to more innovative solutions to manage client cash that put clients’ interests first. Run-of-the-mill savings accounts at online banks yield up to 0.50%, while MaxMyInterest helps clients earn yields of up to 0.75% on same-day liquid, FDIC-insured deposits, held directly in the clients’ own name.

It’s no wonder that leading advisor tools such as OrionEnvestnet | MoneyGuideMorningstar, and Redtail are integrating with better cash solutions that can help clients earn more on cash in their own FDIC-insured accounts.

As advisors seek to find yield for their clients, it may also be appropriate to look at less conventional yield-producing assets that may be less correlated with the market, such as produce anticipation loans, to help clients pick up extra yield.

A barbell strategy of cash plus longer-dated higher-risk assets can help clients pick up yield without sacrificing liquidity.

Many investors have also been seeking yield from dividends on the S&P 500, a trade that worked well in recent years since it offers a 2% yield with plenty of liquidity and a built-in inflation hedge.

However, anything other than cash in a client’s bank account adds risk. Looking at the risk-reward continuum across fixed-income instruments, you’d have to go more than 5 years out on the Treasury curve before you could match the yield available in FDIC-insured savings accounts.

Now is an opportune time for advisors to engage with their clients on the topic of cash and deliver better returns. You just need to know where to look.