Money Funds Lose a Safety Net

Since they were introduced nearly 40 years ago, money-market mutual funds have served as safe and reasonably high-yielding parking places for cash. And for all those years, there has been an implicit promise that the value of a share would stay at $1.

That promise was broken last September, during the worst of the financial crisis, when the Primary Reserve fund (a fund mainly for institutional investors) lost so much money that it "broke the buck" -- its net asset value dropped to 97 cents a share. To forestall a run on money funds' assets by worried shareholders, the Treasury Department created temporary insurance that fund managers could purchase -- and on which, all told, funds spent $1 billion. That insurance program ends on September 18.

No worries

But even though the insurance safety net is gone, "there is a lot of back-end support remaining," says Peter Crane, president of Crane Data, which tracks money funds.

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For one thing, about half of the money in money-market funds is invested in government securities and repos, which are overnight loans secured by the government. Bank certificates of deposit -- including European bank CDs that are guaranteed by European governments -- are also a growing component of money funds' portfolios. In addition, the U.S. government created a loan program to ensure that funds that need to raise cash to meet redemptions will not be forced into selling assets at reduced prices.

The Securities and Exchange Commission is considering new, stronger regulations to further reduce the risks of a run on the funds. The proposed changes, which are likely to be phased in starting at the end of the year, would require funds to have more of their assets in highly liquid securities. Plus, the maximum weighted average maturity of a fund's portfolio, a measure of risk, would be reduced from 90 to 60 days.

Finally, the funds would be banned from investing in "second tier" securities and would have to post their portfolios monthly. Fund managers have already enacted some of the proposed changes, making their portfolios safer.

Shop for better yields

The larger problem for money-fund investors is the pitiful yield. The most recent seven-day yield for taxable funds is 0.06%. Connie Bugbee, editor of the Money Fund Report, a mutual fund industry newsletter, believes that the new regulations could lower yields even further.

If you are not satisfied with money funds' minuscule yield, move your cash to a bank money-market deposit account or to a savings account, where you can find yields of about 2%. But there are some trade-offs: The number of withdrawals you can make each month may be limited, and you may not have check-writing privileges.

You'll find even higher rates at community banks and credit unions. And your money is supersafe, as long as you don't exceed the limits of deposit insurance -- $250,000 per depositor per bank through December 31, 2013. (To find banks and credit unions with high-yielding accounts, go to CheckingFinder at www.checkingfinder.com and enter your zip code.)

If you're willing to step up the risk pyramid for a decent shot at higher returns, consider a short-term bond fund (see Cash Is Trash).