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For years, wary investors retreated to the safety of money market mutual funds when stocks seemed too risky. Now, though, these safe-haven investments have become an endangered species -- but that's OK, because you don't need them anymore.

The rise and fall of money market funds
When money market mutual funds first became available 40 years ago, they provided a way for investors to earn a competitive interest rate on their cash. Bank savings accounts were regulated and paid relatively low rates on deposits, and other investments required larger balances than many investors had available. Money market funds opened up more lucrative investments to small investors, especially during the late 1970s and early 1980s, when high interest rates made it important to maximize the return on your cash.

Today, the tables have turned on money market funds. The Federal Reserve has set short-term interest rates at rock-bottom levels, and corresponding rates are so low on short-term Treasuries, agency securities, and even commercial paper that many money market funds are having trouble earning enough interest just to pay for their expenses. Legg Mason (NYSE: LM  ) is liquidating $23 billion in money market funds, while SunTrust (NYSE: STI  ) is selling its line of money market funds to Federated Investors (NYSE: FII  ) . Charles Schwab (NYSE: SCHW  ) , which has substantial money market assets for its brokerage clients, recently said it lost about $238 million in potential revenue from having to cut its fees on its money market funds.

Why waste your money?
The biggest surprise about this isn't that companies are starting to give up on their money market funds. Rather, it's why this didn't start happening sooner -- and why customers are still keeping their money in the funds at all.

According to Crane Data, the average money market fund is paying 0.10% interest right now. Even the top-yielding fund available to individual investors pays just 0.27%. Meanwhile, many funds pay as little as 0.01%.

Moreover, even some money market funds aren't entirely safe. If you pick a fund that invests solely in Treasury bills, then you don't have to worry much about a default. But with so-called "prime" money market funds, which invest in commercial paper, an issuer that runs into credit problems can sink a fund.

That's what happened to the Reserve Primary Fund, the first money market fund, in 2008. It held a sizable position in Lehman Brothers commercial paper, and when Lehman went bankrupt, the money market fund suffered such big losses that it had to "break the buck" and froze redemptions until it could liquidate.

Higher rates, better protection
In contrast, you can find many banks that are willing to pay you a whole lot more than that. The banking divisions of Capital One (NYSE: COF  ) , American Express (NYSE: AXP  ) , and Discover Financial (NYSE: DFS  ) are just a few of the institutions that will pay you 1% or more on a savings account. Sallie Mae offers 1.4%, and even adds a 10% match to its Upromise program.

In addition to getting more interest for your money, the other big advantage that savings accounts offer is that they're backed by the Federal Deposit Insurance Corp. up to $250,000. In other words, you don't have to worry about a fund breaking the buck; even if your bank happens to go under, you'll still get all of your money back, as long as you stay below the $250,000 limit.

Make your money work harder
Of course, earning 1% may not sound like it's worth the hassle of switching out of a money market fund. But with no sign that the Federal Reserve plans to raise interest rates anytime soon, you may see more financial companies taking matters into their own hands. If their moves force you to move to a better-yielding alternative with your cash, then it'll be a win-win for everyone involved.

Everyone wants to beat rock-bottom bond yields. Alex Dumortier gives you five stocks that will beat bonds.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Fool contributor Dan Caplinger goes wherever he sees the most interest. He doesn't own shares of the companies mentioned in this article. American Express, Discover Financial Services, and Federated Investors are Motley Fool Inside Value selections. Charles Schwab is a Motley Fool Stock Advisor pick. The Fool owns shares of Legg Mason. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy always generates a high rate of interest.

Read/Post Comments (3) | Recommend This Article (9)

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  • Report this Comment On September 30, 2010, at 12:39 PM, BeachPHool wrote:

    Why do I still have money in a money market account? I don't have a choice. With the market uncertainty, I have about 1/2 my 401K account in "cash". My only option is a money market fund that has a negative return. John Hancock doesn't waive its fees, so my money market fund is losing money. Where do I put that money?

    Does anyone know of a company that offers an "under the mattress" account option?

  • Report this Comment On September 30, 2010, at 3:03 PM, Borbality wrote:

    Great advice! I was just looking for somewhere to put some money until I figure out what to do with it. I was really not excited about the .5% the credit union offered. Now I won't feel pressured to put the money into stocks before I'm ready.

  • Report this Comment On October 11, 2010, at 3:44 PM, ChrisBern wrote:

    BeachPHool -- completely agree, there is a need these days for capital preservation, and that's why money is flowing into "safe havens" world-wide. The only suggestion I would make is to diversity into more than just the USD. I haven't looked at it recently, but the Merk Hard Currency Fund or another suitable currency diversification mechanism might be something to consider. I personally believe holding any one currency such as the USD is a risk in and of itself--a risk which can relatively easily be avoided, too.

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