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There's a bull market in fear right now, and investors are scurrying for cover. But one of the worst investments you can make right now is actually one you've been trained to think is a great safe haven with no risk at all.
Money for nothing
If you're looking for possible landmines in your portfolio, the last place you'd probably think to look is your money market mutual fund. After all, money market funds are designed to maintain a stable value of $1 per share, no matter what's going on with stocks, bonds, or other investments.
Despite their reputation, though, money market funds aren't the right place for your money right now. They're stuck between a rock and a hard place; the short-term securities they invest in are paying virtually no interest at all, yet many of them still have at least slight amounts of risk that could threaten their stability in the event of another financial crisis.
The unprecedented decision of the Federal Reserve to keep short-term interest rates at 0.25% or below for 18 months now has been a real headache to money market funds. Typically, funds earn enough in interest from their short-term investments to more than cover their expenses. That can make money market funds quite lucrative for fund managers, which charged an average of 0.34% per year to shareholders in 2009.
Now, though, it's a challenge to earn enough to cover even the full expense ratio, let alone have anything left over for shareholders. Treasury bills with maturities as long as 12 months in the future yield less than 0.25%, and while higher-risk commercial paper has somewhat higher rates, it still hasn't been enough in some cases to make up the difference. As a result, Charles Schwab (NYSE: SCHW ) lost $113 million in potential profits during the second quarter alone from fee waivers, the sixth straight quarter it reported lost revenue from money market fund fees. Bank of New York Mellon (NYSE: BK ) saw fee waivers at its Dreyfus funds rise in the second quarter.
Fortunately, it seems that most money market fund companies won't try to claw back those lost revenues from their customers. Northern Trust (Nasdaq: NTRS ) and JPMorgan Chase's (NYSE: JPM ) funds unit have stated that they have no ability to claim lost fees directly from shareholders. What funds may do, though, is hike their future fees once income levels rise enough to cover them.
In the meantime, though, money market funds are paying a pittance. Even those with extremely low expense ratios are paying 0.25% or less. And you can never be sure there won't be another problem like Lehman Brothers, which caused the Reserve Primary Fund to break the buck, and investors still haven't gotten all their money back from that money market fund.
Get paid what you're worth
What's especially surprising, though, is that you can get paid a lot better for taking less risk. The solution is simple: Use a high-yielding FDIC-insured savings account. Right now, the banking divisions of Sallie Mae (NYSE: SLM ) , Capital One (NYSE: COF ) , and Discover Financial (NYSE: DFS ) offer rates of 1.35% or above, and a host of other institutions are paying more than 1% in interest.
That may not sound like much. But with these bank accounts, you don't have to worry about what toxic assets may be inside your money market fund. You also don't have to worry about whether your bank is making unsound investments, because in the worst-case scenario, the FDIC will make you whole up to its current $250,000 limit.
So whether you're scared enough of the stock market to want to move to cash, or you simply are keeping cash on hand in the hopes of picking up bargain stocks later, one thing is certain: Money you keep in a money market mutual fund isn't working as hard as it could for you. Increasing both your income and your safety factor is the right thing to do, at least until money market funds start paying you more than they are now.
Holding cash won't make you rich. Take a look at what Jordan DiPietro thinks is the best investing opportunity in a decade.