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Interest Rate Misinformation

Copyright © 2007 by David E. Ross

box score for interest rates

Many newspapers provide weekly comparisons of interest rates being paid by banks on their accounts and certificates of deposit (CDs). Often, these comparisons also include the rates being paid by money-market mutual funds; but the mutual fund rates are usually given incorrectly.

The Security and Exchange Commission (SEC) requires mutual funds to quote the rates on money-market mutual funds in terms of their 7-day (one week) actual yield times 52 weeks in a year. However, the newspapers are not subject to that rule and generally compound the yield. As a result, the comparisons you see in the newspapers are not necessarily valid.

The box to the left is from the 20 May 2007 Los Angeles Times. Notice that the top money-market funds appear to be paying more than the top 2½-year and 5-year CDs. Not true! These are false comparisons. The rates paid by money-market funds might change daily, while CDs pay a fixed rate until maturity. Further, while CDs do compound their interest payments, investors might instead have their money-market funds pay out the interest to them.

Thus, the rates cited in newspapers for money-market funds are higher than the rates quoted by the funds themselves. The charts below show the differences between the two on 20 May.

Money-Market FundQuoted Rates
LA TimesFund
TIAA-CREF Institutional Money Market Mutual Fund5.37%5.21%
Vanguard Prime Money Market Fund5.25%5.12%
AARP Money Market Fund5.21%5.08%

Tax Exempt Money-Market FundQuoted Rates
LA TimesFund
Alpine Municipal Money Market (Investor Class)3.89%3.78%
Vanguard Tax-Exempt Money Market Fund3.86%3.77%
Cash Account Trust Tax-Exempt Portfolio
DWS Tax-Exempt Money Fund

Investors beware! Even with savings accounts, CDs, and money-market mutual funds, the old slogan of the New York Stock Exchange is still valid:

Investigate before you invest.
Don't believe the interest rates you read in the newspaper. The differences between what the Los Angeles Times quotes and what the funds themselves quote are about 0.1%. That might not seem like very much. But when you are chasing the highest possible returns, 0.1% can be important. Relying on the newspaper quotes can lead you to choose the wrong investment.

To be fair to the Los Angeles Times, I must point out that the newspaper does not compile the comparisons they publish. They obtain the "box score" from IMoneyNet, an outside service. However, the Times is well aware that IMoneyNet ignores the SEC rules when computing rates.

27 May 2007

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