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Say adios to money market funds

The cocooning trend in investing has to stop.

Cocooning was the phrase coined about 20 years ago to describe the way in which people were choosing to stay warm and comfy at home instead of venturing out. Investors are doing much the same thing today with money market funds, and it's earning them close to zero in returns.

RBC Canadian Money Market, a top performer in its category, is generating a yield of 0.71 per cent just now. On a $5,000 investment, that would get you $35.50 in investment income over a year. Before taxes, that's just enough to cover dinner out for a family of two at a restaurant with paper placemats.

From there, things worsen considerably among the most popular money market choices. TD Canadian Money Market has a yield of 0.41 per cent. Dynamic Money Market is at 0.1 per cent, CI Money Market is at 0.05 per cent and AGF Canadian Money Market Account is making 0.01 per cent.

The most recent comments from the Bank of Canada suggest investors shouldn't expect improved money market returns any time soon. Citing a deepening recession, the bank said last week that it would hold its trendsetting overnight rate steady as long as a year. This is good news for people with mortgages and lines of credit tied to the major bank prime rate, but the flip side is that money market returns are going to stay low, too.

What will turn things around? A strong economic turnaround that creates some concern about inflation. The Bank of Canada doesn't see that happening any time soon, and neither should you. That's why it's time to start executing a strategic retreat from money market funds, which these days are making money only for fund companies as a result of the fees they charge.

The Investment Funds Institute of Canada reports there was close to $75-billion in money market funds at the end of last month at member firms, which compares to $66-billion a year ago and $47.5-billion two years ago. No doubt, the amount invested in these funds would be even higher if not for the competition posed by high-interest savings accounts.

But the amount of money idling in money market funds is still monumental. Based on share prices yesterday afternoon, it was just about enough to buy both Toronto-Dominion Bank and Bank of Nova Scotia.

Emerging from your financial cocoon requires you to think about why you're in money market funds in the first place. Were you looking for something safe that paid a little interest?

Then take a look at guaranteed investment certificates. They're backed by deposit insurance in virtually all cases and they pay as much as 1.5 to 2 per cent for one year. Don't expect rates like that to be posted at your bank, though. You'll have to deal with a credit union or alternative bank, or use an investment adviser or online broker that can shop around for top rates. Deposit brokers - GIC specialists, in other words - are another option.

Other possibilities for money market fund holders seeking interest are preferred shares and corporate bonds. Both have fallen hard in price over the past year or so, which speaks to their safety profile. But you can generate yields of 5 to 6 per cent while sticking with brand-name, blue-chip companies.

Lots of people have used money market funds because they were afraid to invest in the stock markets. Now, it's time to do an updated risk analysis.

The danger of losing money with money market funds is negligible, although not something you can dismiss entirely. The stock markets are a tougher read. They're up encouragingly this year, but we keep hearing about "bear market bounces," which mean upward surges that eventually bow to a broader downward trend. If you transfer a lot of your money market fund holdings into stocks right now, you could quickly lose ground.

But what about a year from now? The Bank of Canada has as much as warned that you'll make close to nothing in money market funds, whereas the stock markets could well be on the road to a sustained recovery.

And what about two years from now? By then, your money market funds might have rebounded along with the economy and be delivering returns of maybe 2 or 3 per cent. Of course, there are no guarantees with the stock market. But the farther out we get from today's uncertainty, the better the chances are that we get a strong rebound from the damage of the past year.

Remember, money market funds do the safe-and-warm thing pretty well. What they don't do right now is generate anything close to an acceptable return.


Parked and idling

Investment dollars held in money market funds are earning close to nothing in many cases, and that's unlikely to change in the next 12 months or so. Here's how a selection of widely available Canadian money market funds stack up:

Assets Current Yield Mgmt Expense
Fund ($-billion) (%)* Ratio (%)
RBC Cdn Money Market6.40.710.89
CIBC Money Market4.80.501.14
TD Cdn Money Market4.60.410.92
Scotia Money Market2.40.531.13
CI Money Market1.80.051.02
Renaissance Money Market1.30.501.08
MD Money1.20.450.56
Investors Cdn Money Market0.90.051.12
Manulife Money Fund D0.90.011.55
AGF Cdn Money Market Acct0.60.011.58
Dynamic Money Market0.50.101.30
*current yield is an estimated return for the next 12 months based on recent short-term results

© 2007 The Globe and Mail. All rights reserved.

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