For years, wary investors retreated to the safety of money
market mutual funds when
stocks seemed too risky
. Now, though, these safe-haven investments have become an
endangered species -- but that's OK, because you don't need them
anymore.
The rise and fall of money market funds
When money market mutual funds first became available 40 years ago,
they provided a way for investors to earn a competitive interest
rate on their cash. Bank savings accounts were regulated and paid
relatively low rates on deposits, and other investments required
larger balances than many investors had available. Money market
funds opened up more lucrative investments to small investors,
especially during the late 1970s and early 1980s, when high
interest rates made it important to maximize the return on your
cash.
Today, the tables have turned on money market funds. The Federal
Reserve has set short-term interest rates at rock-bottom levels,
and corresponding rates are so low on short-term Treasuries, agency
securities, and even commercial paper that many money market funds
are having trouble earning enough interest just to pay for their
expenses.
Legg Mason
(
LM
) is liquidating $23 billion in money market funds, while
SunTrust
(
STI
) is selling its line of money market funds to
Federated Investors
(
FII
) .
Charles Schwab
(
SCHW
) , which has substantial money market assets for its brokerage
clients, recently said it lost about $238 million in potential
revenue from having to cut its fees on its money market funds.
Why waste your money?
The biggest surprise about this isn't that companies are starting
to give up on their money market funds. Rather, it's why this
didn't start happening sooner -- and why
customers are still keeping their money in the
funds
at all.
According to Crane Data, the average money market fund is paying
0.10% interest right now. Even the top-yielding fund available to
individual investors pays just 0.27%. Meanwhile, many funds pay as
little as 0.01%.
Moreover, even some money market funds aren't entirely safe. If
you pick a fund that invests solely in Treasury bills, then you
don't have to worry much about a default. But with so-called
"prime" money market funds, which invest in commercial paper, an
issuer that runs into credit problems can sink a fund.
That's what happened to the
Reserve Primary Fund
, the first money market fund, in 2008. It held a sizable position
in Lehman Brothers commercial paper, and when Lehman went bankrupt,
the money market fund suffered such big losses that it had to
"break the buck" and froze redemptions until it could
liquidate.
Higher rates, better protection
In contrast, you can find
many banks
that are willing to pay you a whole lot more than that. The banking
divisions of
Capital One
(
COF
) ,
American Express
(
AXP
) , and
Discover Financial
(
DFS
) are just a few of the institutions that will pay you 1% or more
on a savings account.
Sallie Mae
offers 1.4%, and even adds a 10% match to its Upromise program.
In addition to getting more interest for your money, the other
big advantage that savings accounts offer is that they're backed by
the Federal Deposit Insurance Corp. up to $250,000. In other words,
you don't have to worry about a fund breaking the buck; even if
your bank happens to go under, you'll still get all of your money
back, as long as you stay below the $250,000 limit.
Make your money work harder
Of course, earning 1% may not sound like it's worth the hassle of
switching out of a money market fund. But with no sign that the
Federal Reserve plans to raise interest rates anytime soon, you may
see more financial companies taking matters into their own hands.
If their moves force you to move to a better-yielding alternative
with your cash, then it'll be a win-win for everyone involved.
Everyone wants to beat rock-bottom bond yields. Alex
Dumortier gives you
five stocks that will beat bonds
.
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Fool contributor
Dan Caplinger
goes wherever he sees the most interest. He doesn't own shares
of the companies mentioned in this article.
American Express, Discover Financial Services, and Federated
Investors are
Motley Fool Inside Value
selections. Charles Schwab is a
Motley Fool Stock Advisor
pick. The Fool owns shares of Legg Mason. Try any of our
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