In a space once dominated by low-interest savings accounts,
money market mutual funds turned the financial world upside-down.
Yet in another example of the long cycles that financial markets
often follow, it looks increasingly likely that money market
funds are an endangered species, and the alternative that may
profit the most from their demise is none other than the good
old-fashioned savings account.
Money market funds under attack
The source of the
latest challenge that money market funds face
comes from financial regulators, who are concerned about the
possible systemic threat they see from the funds. During the
financial crisis in the immediate aftermath of the failure of
Lehman Brothers, the notorious
Reserve Fund
fell below its $1 net asset value, causing losses for some
investors. The fund's "breaking the buck" threw cold water in the
faces of investors who had previously perceived money market
funds as being perfectly safe and secure and led to the
government providing temporary FDIC-like protection for the
investors.
Now, regulators are trying to address the possibility that
such an episode might happen again. Among the solutions they're
trying to press forward are forcing funds to keep capital
reserves to protect against sudden mass withdrawals, or even
allowing the sacrosanct $1 per share standard to give way to a
floating net asset value that would leave investors exposed to
the swings in the money markets, giving investors potential
profits or losses from the funds. Yet industry players have
pointed out that letting fund share prices float would take away
a key element of what makes money market funds attractive to
investors: protection from loss of principal.
The bigger threat
As much as the industry is focusing on regulators, the real
problem that money market mutual funds have to deal with comes
from the
Federal Reserve
. Ultra-low interest rates have made it impossible for many funds
to earn enough interest to pay their once-lofty expenses, and
rather than facing the mass exodus that would result if they
passed on those net losses to their fund customers, the companies
that manage those funds have eaten the losses. That's taken a
big bite out of profits
at
Schwab
(
SCHW
) and other major money fund managers, enough to show up as
material hits to overall net income in quarterly results.
In order to deal with the situation, many brokers have turned
away from money market funds entirely, in favor of a more
traditional solution. Both
E*TRADE Financial
(Nasdaq: ETFC) and
TD Ameritrade
(Nasdaq: AMTD) , for instance, have used relationships with
affiliated banks to offer FDIC-insured accounts as sweep vehicles
for brokerage accounts. These accounts don't offer substantial
interest rates either, but the protection that federal insurance
provides gives customers more assurances than they get from money
market funds.
Banks are back!
For money that isn't locked up in brokerage accounts, savers have
even more options. High-yield savings accounts offering rates
exceeding 1% have popped up in a few corners, and even though 1%
may not seem like anything to write home about, it's a lot better
than anything you'll see from a money market fund or even some of
the riskier short-term bond funds that fund companies have tried
to portray as viable alternatives. Even big money-center banks
Citigroup
(
C
) and
Bank of America
(
BAC
) , which have rarely been particularly competitive on the
interest rates they offer, now look better than money market
funds because of their FDIC insurance.
Whether banks will make money on these deposits in the long
run, however, remains to be seen. Banks themselves are struggling
to find lucrative ways to invest capital, so the true test of
their success will rely on how well they hang onto
savings-account balances even after rates start to rise.
With the Fed's interest rate policies pointing to several
years of low interest rates ahead, money market funds will
continue to face attacks on multiple fronts. Even if regulators
don't end up killing the fund industry with huge changes, it's
still worth the effort for you to take advantage of higher-paying
alternatives that are also safer places to keep your hard-earned
money.
Earning the most on your savings is important, but so is
having a long-term investing strategy for the years and decades
to come. The Motley Fool's special report on retirement investing
is just the place to get information on how to set yourself up
for a more prosperous, secure retirement. Don't wait another
minute -- find out what you need to know about retiring rich
today!
Fool contributor Dan Caplinger spends more time than it makes
sense to spend finding better rates on his money. You can follow
him on Twitter @DanCaplinger. He doesn't own shares of the
companies mentioned. The Motley Fool owns shares of Bank of
America and Citigroup. Motley Fool newsletter services have
recommended buying shares of Charles Schwab and TD Ameritrade.
Try any of our Foolish newsletter services free for 30 days. We
Fools may not all hold the same opinions, but we all believe that
considering a diverse range of insights makes us better
investors. The Fool's disclosure policy is stayin' alive.
Copyright © 1995 - 2012 The Motley Fool, LLC. All rights
reserved. The Motley Fool has a
disclosure policy
.