The money-market fund (MMF), one of the most popular places to keep savings in recent decades, has now fallen out of favor.
Such funds are sometimes confused with money-market accounts (MMAs), but they differ from MMAs in significant ways. Most importantly, MMFs are mutual funds, and as such do not carry FDIC insurance protection as bank and credit union money-market accounts do.
Historically, money-market funds have offered better yields than money-market accounts. And since they have been seen as only marginally riskier than insured money-market accounts, their popularity soared. But no longer. The perceived safety of MMFs took a serious hit in September 2008. That's when the $62.5 billion Reserve Primary Fund "broke the buck" (that is, the value of each share fell below the customary money-fund share price of $1.00), causing the first-ever losses for retail MMF investors. MMF yields have also been stuck near zero for the past four years.
As of this writing, Vanguard's Prime money fund is yielding a mere .04%; Fidelity's Cash Reserves is even worse at .01%. To illustrate this painful point: if you put $1,000 in a fund yielding .04%, after a full year you will have earned only 40 cents. Ouch.
And there's more: A cloud of potential new regulation is hovering over MMFs. The feds, along with regulators from the European Union, are calling for a host of new rules, including capital requirements, investment restrictions, better disclosure, redemption limits and floating net-asset values. If approved, the new rules could further diminish the appeal of MMFs.
What's a saver to do? First, don't throw the idea of having a savings account out with the bad-yield bath water. Indeed, we think most savers should maintain two savings accounts. The first is for an emergency fund, with enough money to cover three to six months of essential living expenses. The second account is for an accumulation fund, which is where you save for purchases you plan to make in the next two to three years.
One of today's best options for an emergency fund is an online savings account. With such accounts, you'll get FDIC insurance, easy access to your money when you need it, and in most cases a much better yield than either MMFs or MMAs are offering. (For more about online savings accounts see our 3-part series about banking online.)
You may want to keep your accumulation fund in an online savings account as well. But, in exchange for a little more risk, you likely can gain a little more yield with a short-term bond fund. Just be forewarned: such funds fluctuate in value, which means they can temporarily lose value. Over a two-year timeframe, however, it's rare for short-term bond funds to lose money. So, when considering such a fund, be sure you have at least two years before you'll need the money.
There are several types of short-term bond funds from which to choose, including the options shown in the table below. Some funds consist primarily of government, corporate, high-yield, or other types of bonds. Other funds mix these bond types together, with the level of risk varying depending on the mix. The most aggressive short-term bond funds may be appropriate in a diversified long-term (i.e., retirement) investment account, but they aren't ideal for short-term savings. Instead, we recommend selecting from among the short-term bond funds in our Fund Performance Rankings. Also, SMI's Income Portfolio Tools can provide details on how various combinations of bond-funds have performed in the past.
Of course, whether it's worth the time and effort to move your savings from an MMF or MMA to an online savings account, or even a short-term bond fund, is up to you. But for savers unwilling to accept 0.04% yields, there are alternatives.