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With yields dropping, Vanguard has had to find ways to cut its already low expenses to keep yields off the floor, observes Dan Wiener of The Independent Adviser for Vanguard Investors.

Vanguard is beginning to worry about yields on its tax-free money markets, and is now going to waive some expenses to "maintain a positive yield," it said in an SEC filing late last week.

This is the same policy they've been using on their taxable money-market funds for some time now.

The language is quite clear: "Vanguard and the Fund's Board have voluntarily agreed to temporarily limit certain net operating expenses in excess of the Fund's daily yield so as to maintain a zero or positive yield for the Fund. Vanguard and the Fund's Board may terminate the temporary expense limitation at any time."

Money markets are a big piece of Vanguard's $1.7 trillion under management, at almost 10% of total assets. Taxable money-fund assets are about $131 billion, while tax-exempt money funds hold $31 billion.

All told, operating expenses on the funds should be bringing in over $300 million in fees per year. Waivers are certainly cutting into that, though Vanguard has never revealed how deep the cuts go.

Why waive expenses now? Yields are sinking rapidly. Since the end of May:

• The yield on the Tax-Exempt Money Market (VMSXX) has fallen from 0.07% to 0.04%.
• CA Tax-Exempt Money Market (VCTXX) has seen its yield go from 0.05% to 0.02%.
• And worse, home state PA Tax-Exempt Money Market (VPTXX) now yields just 0.01%, having fallen from 0.05% at May's end.

When el-cheapo Vanguard has to start waiving expenses to prop up yields, you know interest rates are at rock bottom.

Except for a few brief periods over the past two and a half years, the yield on Tax-Exempt Money Market has actually been higher than that on the taxable Prime Money Market (VMMXX)—which is usually Vanguard's highest-yielding cash fund—despite the expense waivers in place on the taxable fund.

For the past few days, the taxable fund's yield, at a current 0.05%, has been higher, where it normally should be.

It'll be interesting to see if the relationship holds. After huge outflows in April, which are typical of tax time (when investors must pay Uncle Sam), May saw net inflows into Vanguard's money-market funds.

That could be a momentary reprieve. Vanguard investors may begin to vote with their feet when they see their next statement.

Subscribe to the The Independent Adviser for Vanguard Investors here…

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