Money Market Account Interest Rates - Buyer Beware!

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Money market account interest rates are not as variable as some people seem to believe, based on how many comb the Internet looking for the banks which pay the highest rates.

In his book Common Sense on Mutual Funds (Fully Updated 10th Anniversary Edition), John C. Bogle makes an interesting point regarding fixed income mutual funds (which includes both bond mutual funds and money market market funds).

One theme repeated throughout this book is the theme of Bogle's career -- fund expenses are the major factor determining its overall performance.

Money market fund managers really don't have much room to "beat the market." They must follow the stringent regulations of the United States Securities and Exchange Commission. These govern the quality and term of commercial paper which money market funds are allowed to buy.

They must keep the weighted average of the loans they buy very short term - under 90 days. In practice, most money market funds keep their maturies below 50 days.

Money Market Account Interest Rates Can't Vary Too Much

They must place their cash into highly rated (for credit quality) instruments. They may not buy more than 5% of notes from any one supplier, except the United States government (which is assumed to be a perfect credit risk).

Therefore, the business loans which money market funds can buy up is limited to these types.

What is the difference between one 45 day loan from a AAA borrower and another 45 day loan from a different AAA borrower?

Not much.

And that's why money market account interest rates are so similar.

They're all required to invest in the same kind of commercial paper.

What can money market funds do to increase yields?

Two things. One is good for fund account owners such as ourselves. The other is . . . not so good for us.

The fund can keep its expenses as low as possible, leaving more money available for us.

Or the fund can yield to the temptation to take on more risk than other money markets.

When the economy is good, they can get away with it. When it turns south, watch out below.

Low Fund Expense Ratios Create Higher Money Market Account Interest Rates

This happened to several money market mutual funds during the September 2008 financial crisis. They'd taken some extra risk, and suddenly their shares were worth only 97 cents instead of a dollar - the ultimate money market "sin."

Therefore, when you're comparing money market account interest rates, don't take too much risk. If a yield is higher than the competition's make sure you go for the fund with the lowest expense ratio. The fund with the lowest expense ratio is the one that will win in the long run.

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