Few days ago, the Federal Reserve raised its interest rate by 0.25% to a target range of 3.75% to 4.00%.
And this means that the interest rate you are getting on your cash may go up. But it depends where you hold your cash.
For example, if you have a high yield savings account (HYSA), you are at a mercy of your bank. They may increase the rate, but they may not, depending on many factors (e.g. if the bank needs liquidity, they may raise rates)
But Money Market Funds (MMFs) are a lot more responsive, and you will see that 0.25% within ~7 days. This is exactly why my emergency savings are only held in a brokerage account (I use Vanguard), so let me provide a bit more info on MMFs
Basics
MMF is simply a mutual fund that invests in treasury bills, short-term government obligations, and other repurchase agreements. MMF’s goal is to keep their share price at $1 and pay a monthly dividend that is reported as interest (basically similar to a HYSA in a sense of a monthly cash deposit)
Different brokerage accounts offer different MMF funds.
For example, Vanguard, Fidelity, Schwab, and others have various MMFs.
There are generally three categories of MMFs. The main distinctions between these categories are their holdings (what the fund invests in), interest yield, and taxability. Here are the categories:
- Government/Federal
The government/federal funds typically hold more repurchase agreements and government obligations. The interest is not 100% exempt from state tax (but a portion may be), and taxed at a federal level.
For example, each brokerage has its own government/federal fund:
Vanguard: VMFXX with 3.64% yield
Fidelity: SPAXX with 3.33% yield
Schwab: SNVXX with 3.41% yield
- Treasury
The treasury MMF typically invests in the U.S. Treasury Bills and are generally exempt from state/local taxes.
Vanguard: VUSXX with 3.72% yield
Fidelity: FDLXX with 3.39% yield
Schwab: SNSXX with 3.46% yield
- Municipal
Municipal MMFs invest in short term municipal securities that are exempt from federal taxes.
Vanguard: VMSXX with 2.78% yield
Fidelity: FTEXX with 2.12% yield
Schwab: SWTXX with 2.53% yield
When deciding which one to get, it’s important to analyze the after-tax yield since they all have different tax treatments. The best fund is the one that gives you the most after-tax money.
Risks
I want to make sure you are aware of the risks associated with Money Market Funds. First of all, they are not FDIC insured. Your brokerage account is insured with SIPC, which protects customers if your brokerage firm fails.
Secondly, it’s possible for the share price of the mutual fund to fall below $1. For example, during March 2020, some MMFs experienced net redemptions of about 30% of their total assets over a two-week period:
To stabilize the financial system during 2020, the government created liquidity programs to support these funds, ensuring the share price wouldn’t drop below $1.
In 2023, the SEC adopted MMF reforms that increased minimum liquidity requirements for MMFs, providing a substantial liquidity buffer in the event of redemptions.
I’m personally comfortable with it, but it’s something for you to decide.
How to buy?
Many brokerages, like Vanguard or Fidelity, use a Federal Money Market Fund as the settlement account. This means that all you have to do is simply deposit money into the account to start earning interest.
For example, Vanguard uses the Vanguard Federal Money Market Fund (VMFXX) as its settlement fund
If you want to buy a Treasury or Municipal MMF, you can simply click “buy,” type the ETF ticker, and purchase it with your settlement account money. Some of them might have a minimum investment ($3,000) though.
How to withdraw?
If you keep your money in the settlement fund, you can just click “withdraw” and the brokerage will sell the MMF on the back end without you having to do anything (specifically for Vanguard).
If you buy a different fund, like Treasury or Municipal, you might need to sell it first (typically no tax impact). Once that money is in the settlement fund, you can withdraw it to your bank.
Taxes
You will receive a 1099 from your brokerage at the end of the year showing exactly how much interest you’ve received.
In summary, MMFs are not a good investment for the long term obviously. They might be a good place to store your cash for any short-term needs or savings for big purchases. Keep in mind that the yield depends on the current interest rate environment.
See you next Saturday!
MC, CPA