SEC's Money Market Funds Reform May Cause Higher Fees

sec building washington money market fund regulations
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By Tim McLaughlin

BOSTON -- Retail investors may not escape money market fund reform unscathed as the U.S. Securities and Exchange Commission on Wednesday proposed allowing funds to impose new fees and limits on withdrawing money in times of financial distress.

It could be an unsettling proposition for retail investors who have had easy access to their money funds for the past four decades, using them for everything from writing checks to sweeping up extra cash they receive from dividends and selling securities.

The SEC's proposal puts the $115 billion Fidelity Cash Reserves money market fund, for example, squarely in the crosshairs of reform. The fund's shareholder base is largely made up of millions of individual investors who use it as a core brokerage account or cash investment vehicle.

Boston-based Fidelity Investments, the No. 1 money fund sponsor with $420 billion in assets under management, declined to comment as it studies the SEC's proposals.
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New rules could accelerate a shift out of money funds. After peaking at $3.9 trillion in assets in early 2009, money funds have dropped to $2.6 trillion, hurt by next-to-nothing yields and some scares in funds used by institutional investors during the 2008 financial crisis.

And if investors pull more money, it could trigger an increase in fees for investors who remain.

"Any reduction in assets will push costs higher," said Peter Crane, president of Crane Data, which analyzes money funds. "You'll have fixed costs spread over a smaller base and higher costs from more regulation."

Under the SEC proposal, money funds that invest in a broad range of securities -- not just government debt -- could require customers to pay up to a 2 percent fee on withdrawals during times of financial stress. Fund boards of directors could also bar all withdrawals for up to 30 days.

The SEC's goal is to avoid a run on funds like in 2008 when the Reserve Primary Fund "broke the buck" and repriced its shares below the $1 stable share price. That sparked a run on the fund as investors yanked $300 million, or 14 percent of assets.

The redemptions only halted after the U.S. Treasury stepped in and provided a government guarantee. Since then the SEC and the money fund industry have been battling over the shape of reform for the industry.

Earlier this year, Schwab executives said that if redemption restrictions were applied broadly across all types of funds, it would have a "devastating effect on the money market fund industry and render an enormously popular product much less appealing to individual investors and exacerbate systemic risk."

The SEC's proposal is a compromise because it allows funds themselves to determine whether they should impose fees and redemption restrictions. And money market funds that invest mostly in U.S. treasuries would be exempt from the fees and suspension of redemptions. But they could voluntarily opt into the proposed requirement, the SEC said.

"We're pleased the SEC has taken action. We look forward to thoroughly reviewing their proposal, and sharing our views," Charles Schwab (SCHW) spokeswoman Alison Wertheim said.

Meanwhile, retail investors are reconsidering their options. They can move their money to the safety of bank accounts or chase higher yields in slightly riskier ultra-short bond funds.

In fiscal 2008, Fidelity Cash Reserves had $135.06 billion in assets, with the money market fund generating $242.4 million in management fees for Fidelity. But since then, assets and management fees have dropped 15 percent and 17 percent, respectively, according to filings with U.S. regulators.

If You Only Know 5 Things About Investing, Make It These
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SEC's Money Market Funds Reform May Cause Higher Fees

Warren Buffett is a great investor, but what makes him rich is that he's been a great investor for two thirds of a century. Of his current $60 billion net worth, $59.7 billion was added after his 50th birthday, and $57 billion came after his 60th. If Buffett started saving in his 30s and retired in his 60s, you would have never heard of him. His secret is time.

Most people don't start saving in meaningful amounts until a decade or two before retirement, which severely limits the power of compounding. That's unfortunate, and there's no way to fix it retroactively. It's a good reminder of how important it is to teach young people to start saving as soon as possible.

Future market returns will equal the dividend yield + earnings growth +/- change in the earnings multiple (valuations). That's really all there is to it.

The dividend yield we know: It's currently 2%. A reasonable guess of future earnings growth is 5% a year. What about the change in earnings multiples? That's totally unknowable.

Earnings multiples reflect people's feelings about the future. And there's just no way to know what people are going to think about the future in the future. How could you?

If someone said, "I think most people will be in a 10% better mood in the year 2023," we'd call them delusional. When someone does the same thing by projecting 10-year market returns, we call them analysts.

Someone who bought a low-cost S&P 500 index fund in 2003 earned a 97% return by the end of 2012. That's great! And they didn't need to know a thing about portfolio management, technical analysis, or suffer through a single segment of "The Lighting Round."

Meanwhile, the average equity market neutral fancy-pants hedge fund lost 4.7% of its value over the same period, according to data from Dow Jones Credit Suisse Hedge Fund Indices. The average long-short equity hedge fund produced a 96% total return -- still short of an index fund.

Investing is not like a computer: Simple and basic can be more powerful than complex and cutting-edge. And it's not like golf: The spectators have a pretty good chance of humbling the pros.

Most investors understand that stocks produce superior long-term returns, but at the cost of higher volatility. Yet every time -- every single time -- there's even a hint of volatility, the same cry is heard from the investing public: "What is going on?!"

Nine times out of ten, the correct answer is the same: Nothing is going on. This is just what stocks do.

Since 1900 the S&P 500 (^GSPC) has returned about 6% per year, but the average difference between any year's highest close and lowest close is 23%. Remember this the next time someone tries to explain why the market is up or down by a few percentage points. They are basically trying to explain why summer came after spring.

Someone once asked J.P. Morgan what the market will do. "It will fluctuate," he allegedly said. Truer words have never been spoken.

The vast majority of financial products are sold by people whose only interest in your wealth is the amount of fees they can sucker you out of.

You need no experience, credentials, or even common sense to be a financial pundit. Sadly, the louder and more bombastic a pundit is, the more attention he'll receive, even though it makes him more likely to be wrong.

This is perhaps the most important theory in finance. Until it is understood you stand a high chance of being bamboozled and misled at every corner.

"Everything else is cream cheese."
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