yeahman wrote: ↑Tue Feb 05, 2019 10:30 pm
Kevin M wrote: ↑Tue Feb 05, 2019 10:26 pm
I view Prime MM (and Treasury MM and Federal MM) basically as cash accounts. When cash is yielding 2.5%, which is about the same as a 5-year Treasury, why not keep more in cash?
Because it might not be 2.5% for long.
Doc wrote: ↑Wed Feb 06, 2019 9:04 am
Because in a flight to quality situation
the five year Treasury price will increase but the MM fund will not. So it depends on what that "cash" is intended to be used for.
These are both good answers.
The first addresses the tradeoff between price risk (aka, interest rate risk) and reinvestment risk, which I think can both be considered elements of term risk (risk related to term to maturity). The second addresses the function of the fixed income in the portfolio.
A retail money market fund has no price risk, since the share price is maintained at $1.00, even though there is some fluctuation of the value of the fund's holdings (daily market share price has fluctuated between $1.000 $1.0000
and $1.003 $1.0003
over the last six months, with an average of $1.001 $1.0001
). (Edited to correct share price min, max and average)
Reinvestment risk is the uncertainty of the yield when the maturing proceeds are reinvested. With a MM fund, the proceeds are essentially reinvested daily from the investor's perspective, since interest accrues daily. The percentage of Prime MM holdings maturing in one day or less generally is more than 25%, averaging 28% over the last six months, with a minimum of 19% and maximum of 35%. Prime MM yield is highly correlated with the federal funds rate (FFR), so the yield of Prime MM depends mostly on the FFR, and of course that could change at the next FOMC meeting.
Future target rate for the FFR depends on future economic conditions, which no one can predict, so there is fairly high uncertainty in Prime MM yield over a period of more than a few months, and certainly over longer periods than that. Thus, the reinvestment risk of Prime MM is higher than fixed income with longer terms to maturity.
No price risk and high reinvestment risk is typical of fixed income with 0-year term to maturity, so from the investor's perspective, Prime MM has a 0-year term to maturity, although the average maturity of the fund's holdings was 39.0 days as of 1/31/2019.
All holding details are available here: https://investor.vanguard.com/mutual-fu ... olio/vmmxx
As Doc points out, if you want some fixed income that is likely to increase in value in a flight-to-quality scenario, as we saw big time in late 2008, then longer-term Treasuries are your friend (and the longer term, the better for this purpose). This can be particularly useful if your investment policy includes rebalancing from fixed income into stocks, and your rebalancing is triggered by whatever causes the flight to safety scenario; e.g., a big enough drop in stock prices. Such a scenario is where the price risk can pay off (investment risk has an upside as well as a downside), but of course there are other scenarios where the price risk can show up big time, such as extended periods of rising rates and unexpected inflation (the latter is relevant if we think in terms of real price risk as opposed to nominal price risk).