Everyone talks of the benefits of compounding interest but few mention the danger of compounding fees. One particular part of the investment industry that has witnessed a lot is the money market sector. With management fees (this is not including custodial fees/switching fees/distribution fees/commissions) as high as two percent, never has there been a more difficult time for the saver.
Unfortunately, these unreasonably exorbitant fees are driven by an investment service culture that cares more about its own success than yours. As you can see, these extra fees can tally up more than three to four percent a year.
Overall, they can represent more than half your expected gross return. With the top five money market funds (with more than Sh500 million in assets under management) yielding an average effective annual returns of 9.9 percent (as at November 30th), are investors getting the short end of the stick here?
Granted, money market funds are still the safest and profitable investment neighbourhood around - by close of November, the top money market fund had an effective annual yields of 10.75 percent.
Comparably, dividend yields are yielding lower (6.6 percent) and placing your money in a deposit account not only yields lower (6.98 percent) but one is faced with a single exposure to that bank.
Essentially, the goal of these funds is to maintain a net asset value (NAV), or per share value at Sh1. It’s unsurprising why many savvy investors use these funds to park their short-term money.
But that said when fees are taken into account, one sees a different picture. The impact of fees is actually twofold: An investor pays an ever increasing amount in fees as account balances grow, because the fees are based on a percentage of assets. And fees strike a second blow to the portfolio’s returns. That’s because every shilling taken out to cover operational costs is one less shilling left to invest in the portfolio to compound and grow.
To illustrate the point, if you invested one million in a money market fund that produced a 10 percent annual return before expenses and had annual operating expenses of 1.5 percent, then after 20 years, you would have roughly Sh4.9 million.
But if the fund had expenses of only 0.5 percent, then you would end up with Sh6 million. Now, that’s a huge difference.
Beside fees, some of the “high-yielding” money market funds could be flirting with unacceptable risk. While money market funds generally invest in government securities and other vehicles that are considered safe, they may also take some risks to obtain higher yields for their investors.
A fund, in a bid to try to capture another 10th of a percentage point of return, may start investing in corporate bonds or commercial papers that carry additional risk. The point is that a “high-yielding” money market fund may not always be the smartest idea even given the additional risk.
I would suggest not only looking at fees when making investment decision, but investors need to think carefully about what they hope to get from money market funds. To borrow from the (late) Big Pun’s executive caution “I gave you a fat warning, beware.” Pun intended.