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What's the risk to be in money market funds?


muscleman
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I am currently using TD Ameritrade. I was told that they could let me use the cash swap vehicle called "Federated prime cash obligation fund", which is a money market fund that currently yields 1.6% annually whenever I have cash in the account.

Right now my cash is swapped to another government treasury only money market fund that earns very little.

Could anyone give me some advice on this? Is there any risks to have cash in money market funds? I heard in 2008 some money market funds were trading at 80 cents on the dollar though most of the time they trade at the dollar.

Thanks!

 

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Hi muscleman,

Not familiar with the specific instruments you mention but will offer the following comments:

-it seems "money market funds" are very variable and one needs to look under the hood to see the composition of assets and some funds have an unusually high level of commercial paper which occasionally can surprise (on the downside).

-these funds "break the buck" relatively frequently with unexpected bumps but sponsors typically "bail out" the temporary liquidity issue and it's no big deal.

-what happened in 2008 with Lehman failing and with nobody knowing exactly what short term commercial paper was really worth (remember GE?) was highly unusual and could not last. Government intervention was quasi-automatic (even if nobody as far as I know had considered this possibility) as a failing money market meant basically going back to barter trading. With government backing, confidence came back and the buck was no longer broken.

-with "risk-free" rates having gone up quite a bit in the last few months (3mo: 2,30% and 6mo: 2,46%) and if your opportunity cost for this category of your funds is 1,6%, why don't you go with plain vanilla stuff like SHV (minimal duration risk) or SHY (low duration risk)?

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Hi muscleman,

Not familiar with the specific instruments you mention but will offer the following comments:

-it seems "money market funds" are very variable and one needs to look under the hood to see the composition of assets and some funds have an unusually high level of commercial paper which occasionally can surprise (on the downside).

-these funds "break the buck" relatively frequently with unexpected bumps but sponsors typically "bail out" the temporary liquidity issue and it's no big deal.

-what happened in 2008 with Lehman failing and with nobody knowing exactly what short term commercial paper was really worth (remember GE?) was highly unusual and could not last. Government intervention was quasi-automatic (even if nobody as far as I know had considered this possibility) as a failing money market meant basically going back to barter trading. With government backing, confidence came back and the buck was no longer broken.

-with "risk-free" rates having gone up quite a bit in the last few months (3mo: 2,30% and 6mo: 2,46%) and if your opportunity cost for this category of your funds is 1,6%, why don't you go with plain vanilla stuff like SHV (minimal duration risk) or SHY (low duration risk)?

 

Thank you!

I see this one seems to have 45% in commerical paper. So this is usually a bit more risky than money market funds in US government debt only right?

http://www.federatedinvestors.com/FII/mutualfunds/details/portfolioCharacteristics.do?fundshareid=1825&basketid=2761

 

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Inflation.  "Breaking the buck."

I just need a cash sweep vehicle to park my cash temporarily as I am looking for stocks to buy. I am not looking to hold cash over the long term.

Same here. :)

But basically what you're asking is if it matters if you wear sunglasses when crossing a narrow and quiet street (vs being hit by a car). The risk remains extremely low but, from my point of view (risk and reward), I don't see why you should hold commercial paper in your cash-equivalent vehicle.

 

Black swans are rare by definition but occasionally weird things happen.

https://www.bbc.com/news/blogs-news-from-elsewhere-45938724

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Inflation.  "Breaking the buck."

I just need a cash sweep vehicle to park my cash temporarily as I am looking for stocks to buy. I am not looking to hold cash over the long term.

Same here. :)

But basically what you're asking is if it matters if you wear sunglasses when crossing a narrow and quiet street (vs being hit by a car). The risk remains extremely low but, from my point of view (risk and reward), I don't see why you should hold commercial paper in your cash-equivalent vehicle.

 

Black swans are rare by definition but occasionally weird things happen.

https://www.bbc.com/news/blogs-news-from-elsewhere-45938724

 

Yeah.... That's my concern here. It seems to me that these high yield money market funds all hold a large portion of assets in commercial paper.

I am curious how this money market fund is able to get 1.5% yield by investing only in US government obligations. I am sure money market funds can't invest in long term US treasury bills right?

https://investor.vanguard.com/mutual-funds/profile/portfolio/vmfxx

 

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Thank you for the recommendations. I'll call TD to see if they can setup the sweep vehicle using one of these.

Could you please tell me why these two are the best in the game? How did they do in 2008 during the run on money market funds?

 

I see this one has 100% in us treasury bills, and has over 99% daily liquid assets. Is this a good one too?

https://investor.vanguard.com/mutual-funds/profile/portfolio/vusxx

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Yeah.... That's my concern here. It seems to me that these high yield money market funds all hold a large portion of assets in commercial paper.

I am curious how this money market fund is able to get 1.5% yield by investing only in US government obligations. I am sure money market funds can't invest in long term US treasury bills right?

https://investor.vanguard.com/mutual-funds/profile/portfolio/vmfxx

 

I understand that the SEC requires maximum maturities of 13 months or less and average maturities of less than 90 days for money market funds.

For your curiosity, the times, they have been changing.

https://fred.stlouisfed.org/series/TB3MS

https://www.bloomberg.com/markets/rates-bonds/government-bonds/us

 

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Yeah.... That's my concern here. It seems to me that these high yield money market funds all hold a large portion of assets in commercial paper.

I am curious how this money market fund is able to get 1.5% yield by investing only in US government obligations. I am sure money market funds can't invest in long term US treasury bills right?

https://investor.vanguard.com/mutual-funds/profile/portfolio/vmfxx

 

I understand that the SEC requires maximum maturities of 13 months or less and average maturities of less than 90 days for money market funds.

For your curiosity, the times, they have been changing.

https://fred.stlouisfed.org/series/TB3MS

https://www.bloomberg.com/markets/rates-bonds/government-bonds/us

 

 

Wow this is mind blowing. How can the short term rate be so close to 30 yr rate? Hmm...

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Yeah.... That's my concern here. It seems to me that these high yield money market funds all hold a large portion of assets in commercial paper.

I am curious how this money market fund is able to get 1.5% yield by investing only in US government obligations. I am sure money market funds can't invest in long term US treasury bills right?

https://investor.vanguard.com/mutual-funds/profile/portfolio/vmfxx

I understand that the SEC requires maximum maturities of 13 months or less and average maturities of less than 90 days for money market funds.

For your curiosity, the times, they have been changing.

https://fred.stlouisfed.org/series/TB3MS

https://www.bloomberg.com/markets/rates-bonds/government-bonds/us

Wow this is mind blowing. How can the short term rate be so close to 30 yr rate? Hmm...

 

Indeed. But is it fundamental or is it sentimental?

 

Luckily, after all the fundamental work, was able last night to finally figure out the interest rate conundrum and will be able to follow Spekulatius' advice to stop worrying about "economics".

 

The path of interest rates is related to the central bank leader's stature:

https://forbesfinancialonline.com/will-hawks-take-control-2018-bond-market-perspectives-october-24-2017/

 

Still a nagging thought though because mind-blowing has two meanings:

-overwhelmingly impressive.

or

-inducing hallucinations.

 

The money market is dead, long live the money market.

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Yeah.... That's my concern here. It seems to me that these high yield money market funds all hold a large portion of assets in commercial paper.

I am curious how this money market fund is able to get 1.5% yield by investing only in US government obligations. I am sure money market funds can't invest in long term US treasury bills right?

https://investor.vanguard.com/mutual-funds/profile/portfolio/vmfxx

I understand that the SEC requires maximum maturities of 13 months or less and average maturities of less than 90 days for money market funds.

For your curiosity, the times, they have been changing.

https://fred.stlouisfed.org/series/TB3MS

https://www.bloomberg.com/markets/rates-bonds/government-bonds/us

Wow this is mind blowing. How can the short term rate be so close to 30 yr rate? Hmm...

 

Indeed. But is it fundamental or is it sentimental?

 

Luckily, after all the fundamental work, was able last night to finally figure out the interest rate conundrum and will be able to follow Spekulatius' advice to stop worrying about "economics".

 

The path of interest rates is related to the central bank leader's stature:

https://forbesfinancialonline.com/will-hawks-take-control-2018-bond-market-perspectives-october-24-2017/

 

Still a nagging thought though because mind-blowing has two meanings:

-overwhelmingly impressive.

or

-inducing hallucinations.

 

The money market is dead, long live the money market.

 

I called TD and disappointedly, they don't support using the above two vanguard funds as cash sweep vehicles. Their own money market sweep vehicles have expense ratio of 0.78%, which is ridiculous, and the yield is only something like 0.36% after taking that ridiculous expense.

 

Maybe I should just transfer back to IBKR to avoid worrying about these problems.

 

 

Could you please share some thoughts on interest rates and what you have figured out? I appreciate it!

 

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The only two money markets I'm aware of that broke the buck was the Reserve fund in 2008 and people still got 97 cents on the dollar I believe. And the other was in 1994 (not too familiar with that one but read about it).  I would be shocked in Vanguard's money markets (or any of the big diversified funds) ever broke the buck. If Vanguard or Fidelity broker the buck it would be a public relations nightmare. I'd imagine they would back stop them before they let that happen but who knows. Even in 2008, it wasn't like the breaking of the buck came out of no where.

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The only two money markets I'm aware of that broke the buck was the Reserve fund in 2008 and people still got 97 cents on the dollar I believe. And the other was in 1994 (not too familiar with that one but read about it).  I would be shocked in Vanguard's money markets (or any of the big diversified funds) ever broke the buck. If Vanguard or Fidelity broker the buck it would be a public relations nightmare. I'd imagine they would back stop them before they let that happen but who knows. Even in 2008, it wasn't like the breaking of the buck came out of no where.

Paul,

You make it sound so obvious. I was following market developments then with quasi-autistic obsession, but was confused at least half the times and never even considered the possibility that there would be a run on the money market. Relative sleep deprivation and lack of perspective could explain some of that as I was only partially retired then.

 

Reliable reports (including from the SEC) have been made, describing that these funds threatened to break the buck at least on 300 different occasions since the 70’s and the 1994 episode barely broke the buck and the fund was “tiny”. In 2008, what was different was the run. Fascinating when you think about it because it shows how close we came to the brink as these funds are short-term in nature and the run literally occurred on the part of the money market that was responsible for overnight (less than 24h!) funding of large structural and foundational aspects of the US (and world) economy.

 

Consoling to compare, in terms of poor capacity to anticipate events, because important people also seemingly were still dancing:

 

-from the CEO of the “Reserve” fund that “caused” the run (letter from early 2008):

“[T]he tenets that define a money market fund: sanctity of principal, immediate liquidity, a reasonable rate of return– all while living under the overarching rubric of boring investors into a sound sleep.”

 

-from a review (pieces of a puzzle)

 

--September 14th, 2008, GE sends a reassuring a letter to investors (I wish I still had that letter and it has “disappeared” from their website). From memory, things were hunky-dory and access to credit markets was robust.

--September 15th, 2008, GE CEO phones Mr. Paulson and explains that funding has become difficult as lenders’ maximum maturity extend to the next 24 hours.

 

So, over 24 hours, the 24-hour outlook darkened considerably. Of course, dominos had started to fall and things were more fuzzy than the above description and, somehow, GE most likely had been preparing plan B, C, D etc and legend has it that Mr. Buffett authorized his 3B “bail-out” early the day of October 1st, 2008 dressed in his bathrobe when more unexpected events were to occur.

 

@muscleman

 

Probably the best response would have been to let go but FWIW here’s a brief answer submitted mostly because you asked. I think there may be a last puff in there.

 

Reading today how people feel superhuman driving a car, I’ve become particularly humble and sensitive to fallibility. Also writing this makes me realize how much luck has been the predominant factor in trades previously made in government bonds. Since 2010, I have opportunistically and recurrently realized very significant gains from buying and selling long term US and CDN bonds and, since 2016, there is a residual allocation of about 10%.

 

From a certain conventional perspective, with the mind-blowing flattening, a long-short position could be considered (short long-term bonds and long short-term bonds) but conventional is not always right. If you are into multi-dimensional analysis, conventional thinking in risk-free bonds now reminds me of what is expected in multi-stage rocket technology ie the rising short term rates (first stage) in substance means that the energy (assuming no fuel leakage) will be transmitted, through higher long-term rates, to the second stage eventually allowing the economy to reach escape velocity. Humble evaluation of this reveals that the quantitative operation will be delicate and alternative scenarios should be considered.

 

There is a very significant possibility of being wrong here and I’m no rocket scientist but, in terms of a potential asymmetric bet, I find that, among other downside risks, the value of the open-ended equity put embedded in long term “risk-free” government bonds could be mispriced.

 

Some say that “riding the dragon” can only be experienced once but, from limited personal and very natural experiences in investing, the last puff is often the best one.

 

I do not plan on expanding here as unconventional discussions can reveal how one is stupid, really.

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Hey cigar,

 

Thanks for the additional thoughts. I don't mean to make it sound so obvious but if you looked at the rates of comparable money markets, you have to assume that it's riskier. I want to say that Fidelity Cash Reserves was paying about 4.50% while the Reserve Primary fund was paying in excess of 6% (my memory is a little fuzzy on this so I could be wrong). I'm not saying it was obvious that money markets would break the buck (I didn't foresee it either) but when things are obviously out of whack, there is extra risk there.

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Does anyone know US investor's tax implications for buying into these money market mutual funds? I know in general mutual fund investing is tricky for tax reasons, and Peter Lynch advised not to buy any mutual funds near year end because people will have to share with other people the funds' gain in the whole year. Does that apply to money market mutual funds as well?

 

 

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Hi muscleman,

Not familiar with the specific instruments you mention but will offer the following comments:

-it seems "money market funds" are very variable and one needs to look under the hood to see the composition of assets and some funds have an unusually high level of commercial paper which occasionally can surprise (on the downside).

-these funds "break the buck" relatively frequently with unexpected bumps but sponsors typically "bail out" the temporary liquidity issue and it's no big deal.

-what happened in 2008 with Lehman failing and with nobody knowing exactly what short term commercial paper was really worth (remember GE?) was highly unusual and could not last. Government intervention was quasi-automatic (even if nobody as far as I know had considered this possibility) as a failing money market meant basically going back to barter trading. With government backing, confidence came back and the buck was no longer broken.

-with "risk-free" rates having gone up quite a bit in the last few months (3mo: 2,30% and 6mo: 2,46%) and if your opportunity cost for this category of your funds is 1,6%, why don't you go with plain vanilla stuff like SHV (minimal duration risk) or SHY (low duration risk)?

 

I checked SHV, BIL and other money market ETFs. Do you know if the monthly distribution given to me is categorized as interest payment or dividend payment on my tax filings? I notice that on the day of distribution, the price of SHV drops by the equivalent amount. So this means if I buy now at 110.43, and in early November it becomes 110.26 and i got 0.17 distribution, I'll have to pay taxes on that 0.17, and then if I sell SHV on that day at 110.26, I'll have a short term loss of 0.17 which I can't use to offset that 0.17 distribution. Is that right?

 

 

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I called TD and found out that BIL is a commission free ETF, so that seems to be the way to go. The only problem is that if I sell within 30 days, I'll have to pay commission on both buy and sell.

 

They also recommended that I check out FTSM and NEAR. What do you think of these ETFs? What puzzles me is that BIL only has 1 star rating but FTSM has 3 stars and NEAR has 4. I see NEAR has higher expense ratio than BIL and also invests in corporate bonds and foreign bonds, which doesn't seem as safe as BIL. FTSM also has a lot of stuff riskier than cash.

 

 

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