Money Market Funds vs. Bank Deposits: Which Offers Better Returns?

In the past year, money market funds in Israel yielded approximately 4% gross returns, investing in short-term government bonds, bank deposits, and high-grade bonds with maturities up to 90 days. These funds closely track prevailing interest rates. Currently, the projected forward yield for these funds stands at around 3.25%, aligning with the general interest rate in the economy.

In comparison, one-year bank deposits typically offer up to 2.85% interest at most major banks. However, larger clients or those who negotiate terms may secure slightly higher rates. Smaller banks, such as Jerusalem Bank and One Zero, offer more competitive rates, ranging from 3.2% to 3.25%, and in some cases, even higher.

When choosing a money market fund, management fees are a critical factor, with rates varying from 0% to 0.25%. Given the similar yields, even a small difference in fees can be significant. Another consideration is the "addition rate," a type of entry penalty that can impact returns if funds are withdrawn prematurely. The choice between a fund with a low addition rate and higher management fees versus a fund with zero addition rate but higher fees depends on the investment horizon.

Taxation also plays a role: bank deposits are taxed at 15% on nominal gains, while money market funds are taxed at 25% on real gains (profits exceeding inflation). With an estimated inflation rate of 1.5% for the coming year, a 3% deposit yields a net return of about 2.55%. A money market fund yielding 3.25% would result in a net return of approximately 2.82% after taxes on real gains.

Money market funds are generally considered more attractive due to their flexibility in tracking market interest rates, offering a hedge against potential rate increases. While recent global trends suggest potential rate hikes, Israel's current trend is downward, though this could slow future rate cuts. The projected gradual rate reductions over the next 9-12 months are unlikely to significantly diminish the attractiveness of money market funds.