A Primer on CD’s & Money Market Mutual Funds


Since March, the Federal Reserve has been aggressively raising short-term borrowing costs in an effort to tame inflation by slowing down the economy.  By now, most consumers and business owners have started to notice higher borrowing costs, such as mortgage rates topping 7% (not seen in over two decades) and commercial loan rates at even higher levels.  A silver lining to this environment of rising interest rates is that the yield on some of the safest investments — Certificates of Deposit (CD) and money market mutual funds — are now quite attractive.  You, and your business, can finally earn some real money on cash not earmarked for routine expenses.

A CD is a bond (an IOU) issued and guaranteed by a bank or credit union with added protection to you, the investor, via an “insurance wrapper” provided by the FDIC (Federal Deposit Insurance Corporation).  FDIC insurance provides confidence to CD purchasers that, at the maturity of the CD, their principal investment will be returned to them even if the issuing bank has failed and sought bankruptcy protection.  The FDIC came about in 1933 as a result of a broad effort to avert another “bank run”, when depression-era consumers did not have such protections on their deposits and, en masse, demanded their cash back from hapless financial institutions.  FDIC insurance is limited to $250,000 per depositor per issuing bank.

As I write this article in early December 2022, my clients have access to six-month CDs with an APY (annual percentage yield) of over 4.75% and a two-year CD with a 4.9% APY… pretty attractive yields!  The CDs I am referring to are “brokered”, and are available through a competitive marketplace which many financial advisors and brokerage firms have access to on behalf of their clients.

An October 24, 2022 article in the Wall Street Journal pointed out how yields in the brokered CD market are often 1% to 1.5% higher than yields you would expect to see at your local bank branch.  It’s simply the dynamics of an efficient market at work since banks are competing for deposits within the brokered CD distribution channel whereas your local bank branch is counting on the convenience and presumptive strength of a multi-product relationship with their customers.  But if you have more than $250,000 to deposit, the brokered CD channel becomes quite compelling since FDIC coverage can be spread among dozens of participating banks.  Any prudent investor or Treasurer/CFO will not want to exceed the $250,000 FDIC limit since the risk of principal loss beyond the $250,000 of FDIC coverage can so easily be avoided.

What is a money market mutual fund (MMF)?  It is a diversified “cash equivalent” investment that trades at a stable $1 per share and has next-business-day liquidity.  An MMF does not possess FDIC protection but is nonetheless a relatively safe instrument for holding excess liquidity, or strategic cash meant for short-term purpose such as a down payment on a property acquisition or an equipment purchase.  The following list provides an overview of securities commonly held within MMFs.

  • GOVERNMENT SECURITIES: Securities (i.e. bonds) issued or guaranteed by the U.S. government, or by U.S. government agencies.  Also included are repurchase agreements that are fully collateralized by U.S. government securities.
  • COMMERCIAL PAPER: Unsecured, short-term debt instrument that typically matures in less than 270 days and is issued by corporations with strong creditworthiness.
  • ASSET-BACKED COMMERCIAL PAPER: Similar to commercial paper; however, rather than being unsecured, it is backed by specific assets and its risks are dependent on the underlying assets. Corporations whose creditworthiness is not sufficient to issue commercial paper generally issue asset-backed commercial paper.
  • MUNICIPAL PAPER: Tax-exempt, short-maturity securities issued by state and local government agencies and nonprofit organizations, such as private universities and healthcare providers.
  • REPURCHASE AGREEMENT (REPO): The sale of securities coupled with an agreement to repurchase the securities at a specified price at a later date. It is similar to a secured loan, as the lender (in this case the MMF) loans cash to a borrower and receives the borrower’s securities as collateral.
  • CERTIFICATES OF DEPOSIT:  As described above, these are bank-issued short-term bonds having the protective wrapper of FDIC insurance.

There are four “flavors” of MMFs, and they are designed with different objectives in mind.  Of note, yields are not static, and are directionally correlated with the current short-term rates (which rose sharply in 2022 thanks to Federal Reserve actions):

  • Prime (currently yielding about 4%):  The “riskiest” of the MMFs, Prime funds typically have the highest yields.  They often hold all of the above securities with the exception of tax-exempt municipal paper.
  • Treasury: (yielding about 3.7%): Exclusively own short-term securities issued by the US Treasury.  Arguably the “safest” of the MMFs.  Note that it is possible for investors to purchase Treasury Bills directly, which may be a good solution for sizeable purchases.  In my experience, though, CD yields can often be higher than Treasuries of similar maturity.
  • Government (yielding about 3.7%):  Aside from US Treasuries, government MMFs will also purchase agency and REPOs that are fully collateralized by cash or government securities.
  • Municipal (yielding about 2% tax-exempt):  Owning tax-exempt municipal paper, these MMFs pay income that is not subject to federal income tax, a great cash management solution for high tax bracket investors.  Some municipal MMFs are also state-specific, thereby offering income that is tax-free at both the federal and state level for taxpayers domiciled in those states.

How safe are MMFs?  Since they were created in 1971, only three funds have ever “broken the buck.” Two instances occurred during the initial development of the money market industry, and the funds in question held securities that would not meet the reformed criteria of money market instruments today. A third MMF, the Reserve Primary Fund, fell below $1 per share (to 97 cents) during the financial crisis in 2008 as a result of holding substantial amounts of Lehman Brothers’ commercial paper when that storied investment bank declared bankruptcy.  In short, they are very safe securities to hold excess cash and have benefited from direct US government intervention in order to support a $1 per share level during the financial crisis (following the Reserve Primary Fund’s breaking the buck).

A significant advantage of MMFs over CD’s is their next-day liquidity, whereas a CD is intended to be held until maturity.  Of note, while CD’s can be sold prior to maturing, principal could be lost, particularly if interest rates have moved higher since the CD was issued.  But if you have a high degree of confidence around the timing of liquidity needs, the FDIC protection offered by CD’s may offset the potential cost of selling a CD prior to maturity.

If you would like to learn more about cash management instruments like CDs and MMFs, just reach out to me at stu@bendwealth.com or 541-306-4324.

Any opinions are those of Stuart Malakoff and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Investing involves risk and you may incur a profit or loss regardless of strategy selected.



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