New Rules for Money-Market Funds May Force Investors to Consider Cash Alternatives

New regulations are forcing investors to rethink a part of their portfolio that usually doesn't require much attention: cash holdings.

The new rules apply to money market mutual funds, whose stable $1.00 share prices have traditionally made them a popular parking spot for cash. Under Securities and Exchange Commission rules set to take effect in mid October, some money market funds will be allowed to impose fees on shareholder withdrawals or suspend redemptions altogether during times of market stress. And certain money funds offered to big institutional investors must allow their share prices to “float,” or fluctuate along with the market value of fund assets, rather than staying pegged to $1.00.

The changes have prompted investors to yank money out of “prime” money funds, which hold corporate debt and will be most affected by the rule changes, and shift it to government money funds, which will continue to maintain a stable $1.00 share price and won’t be required to impose withdrawal restrictions. Fund companies, meanwhile, are converting many prime money funds to government funds—or simply liquidating them. About $550 billion has moved from prime to government funds since the end of October 2015, according to fund-tracker Crane Data. When the reforms have taken full effect, the number of prime funds will be roughly cut in half from their August 2015 levels, predicts money-fund research firm iMoneyNet.

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The rule changes are designed to protect shareholders by removing investors’ incentive to dump shares at the first sign of trouble in a fund. But “like most things that make you safer, it’s going to cost investors money,” since government funds have lower yields than prime funds, says Peter Crane, president of Crane Data.

The money-fund changes, combined with today’s ultra-low yields, raise the question of whether it makes sense to keep much cash at all in money market funds. Today’s money-fund yields max out at about 0.6%, whereas savers can easily find deposit accounts paying 1% or more at banks covered by the Federal Deposit Insurance Corp. That creates the rarest of investment scenarios: You can get paid more for taking less risk. While money funds are still a good spot to park cash that you want to be able to move into the market at a moment’s notice, banks offer more rewarding options for your emergency fund and other cash holdings.

The new money-fund rules stem from the financial crisis. In 2008, one large money fund’s share price dropped below $1.00 because of its holdings of battered Lehman Brothers debt. That triggered an investor stampede out of prime money market funds.

As the rule changes take effect, keep a close eye on communications from your fund managers, brokerage firm and 401(k) plan provider. Your prime money market funds may be converted to government funds, merged with other funds or liquidated altogether. Although some money funds have traditionally had a mix of institutional and retail investors, that’s no longer viable under the new rules, so “if you’re a retail investor in an institutional fund, you may get kicked out,” Crane says. And some 401(k) plans are dropping money market funds from their menus in favor of stable value funds. Those funds are a completely different animal: They hold portfolios of bonds and use bank and insurance-company contracts to deliver smooth returns.

All prime and municipal money-fund holders will face potential withdrawal restrictions in times of market turmoil. If a fund’s level of “weekly liquid assets”—those that can be converted to cash within one week—falls below 30% of total assets, the fund can impose a fee of up to 2% on all redemptions or suspend redemptions for up to 10 business days. “The whole reason people park money in cash is so they can get to it when they need it,” says Greg McBride, chief financial analyst at Bankrate. In these funds, he says, withdrawals could be restricted “when investors are most likely to want their money.”

Government money market funds aren’t required to follow the new redemption rules—although they can voluntarily adopt them. Money-fund investors who are “looking for the safest of the safe probably want to stay in the government-fund space,” says Mike Krasner, managing editor of iMoneyNet.

The Benefits of Bank Accounts

But investors who want instant access to their money as well as higher yields should consider online savings accounts and rewards checking accounts. Rewards checking accounts offer juicy yields—sometimes 4% or more—but only on balances under a set limit, such as $15,000 or $20,000. To earn the advertised rate, you’ll also need to meet a number of requirements, such as paying bills online and using direct deposit.

Gurnee, Ill.–based Consumers Credit Union, for example, pays 3.09% on balances up to $10,000 if you make at least 12 debit card purchases, make one direct deposit or online bill payment, use online banking, and receive electronic statements each month. Membership in the credit union is available to anyone who pays a $5 one-time fee.

Online savings accounts, meanwhile, are offering top rates just over 1%—but you can earn that rate on much higher balances, and you don’t have to jump through all the hoops that rewards checking accounts require. Popular Direct, Banco Popular’s new online bank, offers a savings account paying 1.26%, with a $5,000 minimum deposit.

If you don’t need quick access to your cash, consider certificates of deposit. Look for five-year CDs with relatively mild early withdrawal penalties of six months’ interest or less, says Ken Tumin, editor of DepositAccounts.com. With these CDs, you can find yields of 2% or more, and you won’t face a harsh penalty if you decide to pull your money out early because rates have climbed or you simply need access to the cash.

Use websites such as Bankrate.com and DepositAccounts.com to find the top yields on online savings and rewards checking accounts and CDs. DepositAccounts.com also offers a tool that helps you find the most-rewarding cash options based on your state, the amount you’d like to deposit and time horizon—as well as the amount of effort you’re willing to expend to maximize your yield. Click “calculators and tools” and then “where to grow your cash.”