Money market yields rise

For the past several years, ultra-short bond funds have served as a higher-yielding alternative to money market mutual funds, but the gap in returns has rapidly been closing.

With taxable money funds currently offering yields averaging about 3.4 percent, according to the Money Fund Report, savers and investors who want to keep some liquid cash are enjoying better returns than they’ve seen in a long time. The current average is the highest it’s been since July 2001, when it stood at 3.5 percent.

Short- and ultra-short bond funds are still yielding a little more, but their advantage as a place to invest cash has definitely narrowed from the days when they delivered twice the returns of money market funds, as they did from 2002 to 2004. A quick glance at Fidelity’s offerings shows the company’s cash reserve fund (FDRXX) yielding 3.70 percent, while Fidelity Ultra-Short Bond (FUSFX) yields 4.02 percent and Fidelity Short-Term Bond (FSHBX) delivers 4.29 percent. Both have below-average expenses, an important factor in investments with low returns.

What you decide to do with your cash depends on when you plan to use it, said Scott Berry, an analyst with Morningstar Inc. With the yield landscape changing so rapidly, it makes sense to evaluate all the alternatives. Money market funds hold great appeal because they offer increasingly attractive yields with little to no risk to principal. That said, if you don’t plan to touch your cash for at least a couple years, or if you need a place to stash an emergency fund that you hope never to tap, ultra-short funds still make good sense.

“If you look at performance of money market funds versus ultra-shorts, ultra-shorts have really held up well,” Berry said. “They’ve done what they were designed to do: They’ve preserved principal and provided more yield than the money market. And even though the gap has narrowed, they’re still yielding more … and over time that little bit can add up to a lot.”

What definitely doesn’t make sense these days when it comes to fixed income investing is taking on added risk with longer durations. Strange things are afoot in the bond universe when two-year Treasurys and five-year Treasurys deliver almost the same yield – both are hovering just above 4.3 percent, not much above the yields on six-month Treasurys.

Normally, investors expect higher yields for committing their money over longer periods, but the market is spooked by questions about the economy, inflation and possible changes in the policies of the Federal Reserve after Chairman Alan Greenspan retires early next year. This has resulted in a flattening of the yield curve, which some observers believe will eventually invert – meaning shorter-term Treasurys will start to yield more than those with longer durations. Some market watchers say this would signal an economic downturn, but others argue the economy is doing just fine.

The market is still absorbing the last hike in short-term interest rates, issued Nov. 1, and anticipating the next one, expected when the Fed meets Dec. 13. This very likely will push average money market rates close to or past 4 percent, said Peter Crane, managing editor of iMoneyNet, publisher of the Money Fund Report, which has tracked money market funds since 1975. What remains to be seen is how much closer yields will edge toward 5 percent – something cash investors haven’t seen since 1999 and 2000.