The Hidden Cost of Parking Cash: Are Money Market Funds Worth It?

In times of market uncertainty, many investors seek refuge in the perceived safety of money market funds. These funds, designed to maintain a stable $1 share price and provide liquidity, seem like a logical place to park cash while waiting for the storm to pass. However, this apparent safety net comes with a hidden cost: expense ratios.

Many money market funds carry surprisingly high expense ratios, which are essentially management fees expressed as a percentage of your investment. While these fees might seem small, they can significantly erode your returns, especially when compared to other investment options. According to the Investment Company Institute (ICI), the average money market fund fee is 0.38%. This is substantially higher than the average 0.05% fee charged by index equity mutual funds.

To put this into perspective, for every $10,000 invested in a money market fund with an average expense ratio, you’ll pay $38 annually in fees. In contrast, the same investment in an index equity mutual fund would only cost you $5 per year. Over time, these seemingly small differences can add up, potentially costing you a significant portion of your investment gains.

It’s crucial for investors to be aware of these fees and avoid falling into the trap of overpaying to hold cash. A money market fund is a type of mutual fund that invests in short-term, high-quality debt securities, such as Treasury bills and certificates of deposit. The primary goals of these funds are to maintain high liquidity and stability, making them attractive to risk-averse investors.

While searching for a money market fund with a lower expense ratio is a good starting point, financial experts advise that these funds should ideally be used for short-term needs only, unless the investor is elderly and highly risk-averse. Ronnie Gilliken, president and chief executive of Capital Choice of the Carolinas, emphasizes that using money market funds for anything beyond short-term goals can be a significant missed opportunity for growth.

The returns offered by money market funds are typically not high enough to generate substantial wealth over extended periods. Gilliken points out that money market fund rates typically aren’t enough to fulfill the Rule of 72 over a short timeframe. The Rule of 72 is a simple formula used to estimate how long it will take to double your money at a given interest rate. By dividing 72 by the interest rate (expressed as a percentage), you can approximate the number of years required to double your investment.

Currently, the average yield for money market funds is around 4.14%, based on data from the ICI Fact Book for 2025. While this yield might seem attractive in the current environment, it’s important to consider the impact of inflation and the potential for higher returns from other investment options.

However, Gilliken cautions investors against solely relying on expense ratios when making investment decisions. He argues that focusing solely on minimizing fees can lead to overlooking potentially high-performing funds. Instead, investors should prioritize net returns, which reflect the actual gains after deducting all expenses. By focusing solely on expense ratios, investors risk eliminating potentially outperforming funds from the outset.

To illustrate this point, consider the example of a $10,000 investment made in 1976, when Vanguard launched its first low-cost Vanguard 500 Index Fund. The fund had an expense ratio of 0.14% at its inception, which has since decreased to 0.04%. If that initial investment had been maintained through 2023, it would have grown to $1,704,343.

However, compare that to the $2,455,295 that would have been earned had the money been invested in the five U.S. equity-focused American Funds available at the time. This higher return, despite the American Funds’ higher expense ratio and a maximum sales charge of 5.75% for equity funds, demonstrates the importance of focusing on net returns.

Gilliken explains that the higher expense ratios of actively managed funds often reflect the extensive research and analysis conducted by fund managers. Before investing in a company’s stock, analysts from the mutual fund company typically visit the company, meet with the chief executive and board members, review the company’s financials, tour production facilities, and analyze the company’s performance relative to its competitors. Furthermore, if the company operates in a foreign country, analysts assess political risks and relevant legislation.

This comprehensive research is all included in the expense ratio. In contrast, an index fund simply mirrors the performance of a specific market index without conducting in-depth analysis of individual companies. Gilliken argues that "an index is just a thermometer of what is going on" but doesn’t look at each individual company. He adds that "just because the company’s big and in the index doesn’t necessarily mean you should own it."

Sometimes, a slightly higher expense ratio can be justified by the potential for superior performance and risk management. For example, the energy company Enron was a component of the S&P 500 index before its collapse due to widespread accounting fraud. This highlights the risk of blindly following an index without considering the underlying fundamentals of individual companies.

While research, including studies from the Wharton School of Business, suggests that active investment managers often struggle to consistently outperform the market enough to justify their higher fees, Gilliken believes that skilled managers can add value through their expertise and due diligence. If an investor can find a manager who consistently delivers superior returns, then "we deserve our compensation," he concludes.

Ultimately, the decision of whether or not to invest in a money market fund, or any investment for that matter, should be based on a comprehensive assessment of your individual financial goals, risk tolerance, and time horizon. While expense ratios are an important factor to consider, they should not be the sole determinant of your investment choices. Focusing on net returns and understanding the value that active management can potentially provide are crucial for making informed investment decisions. Don’t let the allure of safety blind you to the potential costs and missed opportunities that come with simply "parking" your cash.