Money Market Funds Are Not a Free Lunch — Oblivious Investor

Over the last year, one thing I have noticed is far greater money market balances than I used to see in people’s portfolios. I’m encountering lots of people who are using money market funds for the entire fixed-income side of their portfolio — or nearly so.

And it’s easy to understand the line of thinking here. For instance, take a look at the yield curve for nominal Treasuries (as of 8/22/24):

1 Mo	2 Mo	3 Mo	4 Mo	6 Mo	1 Yr	2 Yr	3 Yr	5 Yr	7 Yr	10 Yr	20 Yr	30 Yr
5.51	5.35	5.28	5.15	4.96	4.43	3.99	3.82	3.72	3.77	3.86	4.21	4.13

 

The shortest maturities have the highest yields.

And, naturally, we see the same pattern with mutual funds. For example (again as of 8/22/24):

• Vanguard Federal Money Market Fund has an SEC yield of 5.25%.
• Vanguard Short-Term Treasury Index Fund has an SEC yield of 4.15%.
• Vanguard Intermediate-Term Treasury Fund has an SEC yield of 3.82%.
• Vanguard Long-Term Treasury Fund has an SEC yield of 4.09%.

Again, the shortest maturities have the highest yields.

Combine that with the fact that shorter duration also means less price volatility (money market funds explicitly seek zero price volatility, even), and it’s easy to see why people are opting for money market rather than riskier bonds with lower yields.

But I think it is helpful to back up and ask: why would the market allow us to get a higher yield for less risk? Why aren’t huge investors coming in and buying up enough very short-term Treasuries in order to push the yields down (or selling intermediate-term Treasuries enough to push their yields upward)?

Why would the market, collectively, be as interested in a 5-year Treasury bond with a 3.72%  yield as in a 1-month Treasury with a 5.51% yield?

One answer is that the market expects interest rates to fall. (And, based on the yield curve, it appears to have been expecting such since last summer.) In other words, the market does not expect that investors buying today will be able to keep rolling over those 1-month Treasury bills at a 5.51% rate for the entire next 5 years.

Will that actually happen? I don’t know.

But it’s important to recognize that sticking solely with super short-term fixed-income isn’t an automatic “win.” If you want, you have the option to “lock in” today’s rates, for a longer period of time. That isn’t necessarily a win either, but it isn’t automatically detrimental.

(As I wrote recently, for our own portfolio, the entirety of the fixed-income balance is currently in long-term individual TIPS, which, given their current yields of roughly 2% above inflation, we’d be happy to simply hold to maturity. I do not know how or when interest rates will change, but I do know that I’ll be quite satisfied with the bond portion of our portfolio earning a 2% real return for the next 25-30 years.)