SPAXX and VMFXX are seeing inflows but beware of these risks

The Fidelity Government Money Market Fund (SPAXX) and the Vanguard Federal Money Market Fund (VMFXX) have been two of the hottest investments this year as interest rates jumped. These funds have seen more inflows as investors move from risky assets to higher-yielding and low-risk assets.

Money Market Funds growth

SPAXX and VMFXX are two of the biggest money market funds (MMF) in the financial services industry. Fidelity’s SPAXX has over $282 billion in assets under management while Vanguard’s VMFXX has over $289 billion.

These funds are benefiting from the rising interest rates in the United States. The Federal Reserve has hiked rates from zero to 5.50%, the fastest pace of increase in years. As a result, many people have moved from riskier assets like stocks and cryptocurrencies to the relatively safe cash.

Many American banks have expressed concerns about deposit flight to these assets. Besides, it makes sense moving funds from an ordinary account that earns less than 3% to a liquid fund that brings in over 5%.

Demand for money market funds has been spread across individuals and institutional investors. Indeed, a recent report showed that money market fund investments have surged to over $5.6 trillion. Asset managers have allocated a small portion of their funds to these funds.

There are three main reasons why people are considering these funds. First, investors are now able to generate over 5% returns simply by doing nothing. Such returns were unheard of after the Global Financial Crisis (GFC) in 2008. At the time, the Fed brought interest rates to zero and embarked on a quantitative easing program.

Second, the market has gotten quite volatile lately. While the S&P 500 index has jumped this year, these gains are mostly because of big-tech companies like Meta Platforms and Nvidia. Most companies in the index have seen modest growth.

Third, some of the biggest high-yielding assets like REITs are going through major headwinds as maturities near.

Risks for SPAXX and VMFXX

While these funds are good investments, there are a few reasons you might consider avoiding them. First, unlike dividend stocks, these money market funds offer little or no dividend growth. This is a major challenge. While dividend stocks like REITs are struggling, many of them are having robust dividend growth. In this case, we recommend finding quality dividend ETFs and investing in them.

Second, there is the ongoing inflation risk. A quick look a SPAXX and VMFXX shows that they are yielding 5% and 5.43%, respectively. While these are good returns, they are minimal when you consider inflation. Official inflation stands at 3.6%, meaning that investors are making less than the advertised 5%.

Third, money market funds have negative tax implications compared to stocks and municipal bonds. These assets are taxed as general income and not as capital gains or dividends, In most cases, these money market funds taxes can be higher than those on stocks.

Most importantly, there is interest rate risks. While the Fed has delivered numerous rate hikes this year, there is a likelihood that it will slash them in 2024. In most cases, money market funds have lower yields in a low interest-rate environment.

Finally, historically, money market funds have lower yields than stocks while these funds are more expensive than popular ETFs like SPY and QQQ. Therefore, while these funds are good for now, investors should consider investing in quality dividend stocks that have been crashed. You can find some quality and cheap stocks in areas like REITs, BDCs, and MLPs.

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