The recent news that Absa was closing down its reliable and popular money market fund caught the market by surprise, flooding it with speculation about the reason for this move. Given the size of the fund – around R80-billion – the reasons cited by Absa didn’t fully convince, but the move did raise a number of other important questions.
Absa said its decision was motivated by clients who perceived the fund as being guaranteed by the bank. A second reason given, was that clients tended to incorrectly use the fund as a bank account.
Other reasons – purely speculative – could have been the current low interest rate environment in which fees are proportionately higher compared to when interest rates are high. Concern over credit risk could have been another factor. Or the move could have been inspired by the fact that various debt instruments, including with other banks, are used in a money market fund to increase the return. Absa may have viewed this as giving away business that could rather have been secured for their own banking products. Who knows?
However, a number of other more pertinent questions were indeed raised by this move. For instance, what other options do the affected Absa clients now have? Do clients always fully understand the purpose of a money market fund? And what are the risks and options involved?
If indeed many Absa money-market clients used the fund like a bank account, one could assume they may now switch to a normal bank account. But these accounts may have costs plus low interest attached. Money market funds are attractive because of their liquidity – instant access to capital – and a return that is often in line with inflation. For a similar return in a banking product, you would have to consider a term investment, but you would lose the liquidity benefit.
Typically, a money market fund should be used for short-term savings that may include saving for a car, a deposit for a house, a rainy-day emergency fund or for an overseas trip. But many investors use a money market fund for long-term savings and even to draw a monthly income. Seen in perspective, with the current low-interest environment, the expected interest from a money market fund is around 3.630% per year (source: www.moonstone.co.za). Considering that inflation is currently around 3.2% (source: www.tradingeconomics.co.za), this leaves a real return of only 0.43% per year or even less if inflation ticks upwards over the medium term, as is expected by the South African Reserve Bank.
To draw an income of R5,000 per month from R1-million invested and allowing for an annual inflation-linked increase, your capital will only last 17.3 years. Based on the same calculation but using an expected return of inflation plus 4% after costs (which is still reasonably conservative), the capital will last 27.3 years.
We often see people opting for money market products for the wrong reasons. They either don’t trust advisors or feel that they “don’t know enough” to start investing, and then revert back to what they believe to be familiar and safe. Such a decision could cost them 10 years’ worth of income growing annually at inflation!
So, Absa’s closing down of its money market fund may be a blessing in disguise for many investors who can use this as an opportunity to reassess the purpose of their investment and seek good advice, even getting more than one opinion. Choose credible advisors and ensure they are qualified, hold professional indemnity insurance, and are registered with the Financial Sector Conduct Authority (FSCA). Interrogate the costs you pay and feel free to ask exactly what they are for. In most cases the advice will far outweigh the cost.
So, back to the question, why invest in a money market fund? Simply put, for any savings that need to be quickly accessible and are stable with little to no volatility. But even if money market funds tick these boxes, remember they are still not guaranteed products and you could in some cases incur capital losses. Therefore, it’s best to use them for specific short-term saving goals or to build up an emergency fund of approximately 3-6 months’ worth of expenses. For anything else, invest in a suitable product with a longer-term focus.
Finally, before replacing your money market fund with another, first thoroughly consider the real reasons and purpose of your investment. Remember, running out of capital is a real risk too and may well happen if your investments are not planned and structured effectively.
Theoniel McDonald is Managing Director of Wealth Associates Central, Strategic Marketing Director of Wealth Associates South Africa, and is an Elected Director of the Financial Intermediary Association (FIA).