Money Market Funds

Back in the days when mutual fund companies used to focus on ways to help consumers - before the marketing guys took over and start pushing bad product out the door - money market funds were, at one time, an innovative product that enabled investors to get higher yields than were available on bank savings products. In the early 1970's, when the Federal Reserve was still in the habit of regulating interest rates - capping what banks could pay depositers - the money market mutual funds allowed investors an entry into the commercial paper marketplace, where corporate and financial borrowers were paying much higher rates of interest on short-term paper. By bundling savers' moneys together into a mutual fund, the mutual fund companies made it possible for investors to benefit from those higher yields.

These days, however, the mutual fund companies are replacing innovation with exploitation. The major financial services companies switch customers into new accounts with ongoing fees, regardless of activity, and then hope that these customers just let their money sit so the "financial advisor" can enjoy the best of both worlds, recurring fees with no actual work to do for the client. The financial services companies call this "annuitizing the book of business" because it turns a client into a constant fee source, though I can think of other names that better describe what the client is getting.

In recent years, several large brokerage firms have taken exploitation a step further. Noting that many brokerage accounts sit uninvested in anything except money market funds, brokerages like Charles Schwab, Citigroup (Smith Barney), Wachovia, and more recently Wells Fargo, have realized that they can do a lot more than merely scrape a 1/2% annual fee off money sitting in a money market fund. Now they are starting to automatically sweep uninvested cash into deposit accounts with their bank affiliated subsidiaries.

Investors, instead of receiving a fair market interest rate (currently 4.5% to 5.0% in a taxable account) receive only a fraction of that amount. Many investors will receive less than 2% on the money, while the bank subsidiary has the opportunity to turn around and lend that money out at a "prime" rate of interest (above 8% at the moment). You can see why the bank subsidiaries are salivating at the chance to earn 6% on the spread, instead of a 1/2% fee for managing the money market fund. What is less clear, of course, is why investors shouldn't be hopping mad at their broker once again giving them the short end of a conflict of interest.

There is already at least one class action suit levied on behalf of investors for this practice. But it is no wonder that investors place do not trust their brokers. Given practices like this, the brokers do not deserve their trust!

Schwab used to be a very customer-centric firm. It is really a shame to see them adopt this practice. I expect it from the wirehouse and bank firms. But really, Mr. Schwab, as long as this is your modus operandi, the housecleaning at Schwab isn't over yet.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

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