As the Federal Reserve pushes short-term interest rates higher, investors in money-market mutual funds don't mind a bit. You could say Chairman Alan Greenspan is giving them a raise.

For the 21 million-plus U.S. investors who own money-fund shares, interest-rate increases that take place now mean higher yields soon on their investments. The funds buy short-term, interest-bearing securities such as Treasury bills and commercial paper issued by corporations.

Since the start of 1999, the average seven-day compound yield on money funds has risen to 5 percent from 4.6 percent, according to IBC Financial Data Inc. in Massachusetts.

With the Fed's recent announcement of the third quarter-point increase since June in the overnight bank-lending rate, yields could well keep moving up. They usually follow trends in open-market interest rates with a lag of several weeks, as money-fund managers replace maturing securities with new ones carrying current market rates.

"Money-market funds are looking sweet," said Dan Wiener, who edits the newsletter Independent Adviser for Vanguard Investors.

In the past two years, assets of money funds have soared almost 50 percent, to more than $1.5 trillion, as tallied by the Investment Company Institute, the fund industry's biggest trade group. They account for one of every four dollars invested in funds of all types.

Money funds, sometimes known as "cash" in financial shorthand, have achieved that growth even though their yields can't begin to keep up with double-digit gains year after year in the stock market.

"Investors are racing to build their cash positions to keep pace with their stock positions," said Peter Crane, managing editor of IBC's Money Fund Report.

With net-asset values that don't fluctuate, money funds have become a favorite means of diversification for investors who want to keep riding the bull market in stocks as long as it lasts, but with stabilizers in place.

Although they are not covered by federal deposit insurance, money funds have established a reputation for safety. They're not subject to the price setbacks that hit most longer-term bonds and bond funds when interest rates rise, as they did in 1994 and again this year.

"Since 1994 money funds have been taking market share away from bond funds," Crane said. As recently as the end of 1993, bond funds held more assets than money funds. Now money funds are more than 75 percent bigger than the bond funds, which have about $830 billion.

Prev

For reprint and licensing requests for this article, CLICK HERE.