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These funds may offer attractive yields as interest paid on cash tumbles
The Federal Reserve is about a month into its rate-cutting cycle, and money market fund yields are already starting to pay less. Total money market fund assets grew to $6.47 trillion as of the week ended Oct. 9, according to the Investment Company Institute . But the income those assets are generating is well off the highs. The Crane 100 Money Fund Index has an annualized seven-day yield of 4.69% as of Oct. 14, down sharply from late July when it topped 5.1%. These yields – along with what banks are willing to pay on deposits – are expected to continue sliding as the Fed dials back interest rates. That means it may pay for investors to start looking for alternatives if they’re holding onto idle cash that they may not need for the next 12 to 18 months but still want to generate some interest income. “There’s $6 trillion in cash right now, and investors want the next step out of cash,” said Brett Sheely, head of ETF specialists at AllianceBernstein. That’s where short and ultra-short duration bond funds and ETFs may come into play. An eye on duration Duration is a measure of a bond’s price sensitivity when interest rates fluctuate. Issues with longer maturities tend to have greater duration. Generally, financial advisors have been recommending that investors add some exposure to duration – ideally in the “intermediate” category of about six years – as the Fed lowers rates. This way, investors benefit from price appreciation, as bond yields and prices move inversely to one another, and they lock in today’s relatively higher yields. Short duration, however, may make sense for proceeds that investors will need in the next year or so. These instruments won’t see sharp swings in their prices as rates change, but they can still offer a little more yield compared to cash even as the Fed lowers rates. That’s where short-term bond funds and ETFs come into play. “How can you earn relatively high yield but do it in an environment where you don’t put so much capital at risk and preserve some principal?” asked Matthew Bartolini, managing director at State Street Global Advisors and head of SPDR Americas Research. In that case, ultra-short bond funds and short-term bond funds might be “a natural landing spot for that cash.” Those ultra-short bond funds have one to three years of duration and offer some stability day to day, Bartolini added. Options include Vanguard’s Ultra-Short Bond ETF (VUSB) , which has an expense ratio of 0.1% and a 30-day SEC yield of 3.54%. The fund has a duration of less than a year. AllianceBernstein’s Ultra Short Income (YEAR) , meanwhile, has an expense ratio of 0.25% and a 30-day SEC yield of 4.81%. Tax-conscious investors may also consider short-duration municipal bond funds, AllianceBernstein’s Sheely said. Municipal bonds offer tax-free income, while corporate bonds produce interest income that’s subject to rates as high as 37%. Investors looking at these short-duration funds should be aware that they are taking a little more risk in exchange for that additional yield. A few ultra-short bond funds took their knocks in 2008 as they carried risky nonagency mortgage bonds that suffered during the financial crisis, spurring investors to flee. Don’t let high yields drive your decision, and be sure to understand the credit quality of the holdings in your fund. ‘Safer’ picks For investors who would prefer not to take the risk of a short-duration bond fund or ETF, certificates of deposit and high-yield savings accounts are still available. Bread Financial — once home of the one-year CD with an annual percentage yield of 5.25% — has recently dialed back its APY to 4.3%. “We expect Savings rates to fall further as online banks recalibrate against each other,” said BTIG analyst Vincent Caintic in a report on Sunday. He noted that Bread also trimmed its APY on savings accounts to 4.75%, marking a 20-basis point reduction week over week. Further, the Federal Deposit Insurance Corp. backs bank CDs and savings accounts up to $250,000 per depositor and per ownership category, an extra measure of safety. Treasury bills, which are backed by the full faith and credit of the U.S. government, are also another safe alternative for investors who are looking for the next best alternative to cash they may tap in the next year or so. Further, interest on T-bills is subject to federal income taxes, but not state or local taxes – which can be a bargain for high-income investors residing in high-tax states like New York, New Jersey and California.
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