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In a space once dominated by low-interest savings accounts, money market mutual funds turned the financial world upside-down. Yet in another example of the long cycles that financial markets often follow, it looks increasingly likely that money market funds are an endangered species, and the alternative that may profit the most from their demise is none other than the good old-fashioned savings account.

Money market funds under attack
The source of the latest challenge that money market funds face comes from financial regulators, who are concerned about the possible systemic threat they see from the funds. During the financial crisis in the immediate aftermath of the failure of Lehman Brothers, the notorious Reserve Fund fell below its $1 net asset value, causing losses for some investors. The fund's "breaking the buck" threw cold water in the faces of investors who had previously perceived money market funds as being perfectly safe and secure and led to the government providing temporary FDIC-like protection for the investors.

Now, regulators are trying to address the possibility that such an episode might happen again. Among the solutions they're trying to press forward are forcing funds to keep capital reserves to protect against sudden mass withdrawals, or even allowing the sacrosanct $1 per share standard to give way to a floating net asset value that would leave investors exposed to the swings in the money markets, giving investors potential profits or losses from the funds. Yet industry players have pointed out that letting fund share prices float would take away a key element of what makes money market funds attractive to investors: protection from loss of principal.

The bigger threat
As much as the industry is focusing on regulators, the real problem that money market mutual funds have to deal with comes from the Federal Reserve. Ultra-low interest rates have made it impossible for many funds to earn enough interest to pay their once-lofty expenses, and rather than facing the mass exodus that would result if they passed on those net losses to their fund customers, the companies that manage those funds have eaten the losses. That's taken a big bite out of profits at Schwab (NYSE: SCHW  ) and other major money fund managers, enough to show up as material hits to overall net income in quarterly results.

In order to deal with the situation, many brokers have turned away from money market funds entirely, in favor of a more traditional solution. Both E*TRADE Financial (Nasdaq: ETFC  ) and TD Ameritrade (Nasdaq: AMTD  ) , for instance, have used relationships with affiliated banks to offer FDIC-insured accounts as sweep vehicles for brokerage accounts. These accounts don't offer substantial interest rates either, but the protection that federal insurance provides gives customers more assurances than they get from money market funds.

Banks are back!
For money that isn't locked up in brokerage accounts, savers have even more options. High-yield savings accounts offering rates exceeding 1% have popped up in a few corners, and even though 1% may not seem like anything to write home about, it's a lot better than anything you'll see from a money market fund or even some of the riskier short-term bond funds that fund companies have tried to portray as viable alternatives. Even big money-center banks Citigroup (NYSE: C  ) and Bank of America (NYSE: BAC  ) , which have rarely been particularly competitive on the interest rates they offer, now look better than money market funds because of their FDIC insurance.

Whether banks will make money on these deposits in the long run, however, remains to be seen. Banks themselves are struggling to find lucrative ways to invest capital, so the true test of their success will rely on how well they hang onto savings-account balances even after rates start to rise.

With the Fed's interest rate policies pointing to several years of low interest rates ahead, money market funds will continue to face attacks on multiple fronts. Even if regulators don't end up killing the fund industry with huge changes, it's still worth the effort for you to take advantage of higher-paying alternatives that are also safer places to keep your hard-earned money.

Earning the most on your savings is important, but so is having a long-term investing strategy for the years and decades to come. The Motley Fool's special report on retirement investing is just the place to get information on how to set yourself up for a more prosperous, secure retirement. Don't wait another minute -- find out what you need to know about retiring rich today!

Fool contributor Dan Caplinger spends more time than it makes sense to spend finding better rates on his money. You can follow him on Twitter @DanCaplinger. He doesn't own shares of the companies mentioned. The Motley Fool owns shares of Bank of America and Citigroup. Motley Fool newsletter services have recommended buying shares of Charles Schwab and TD Ameritrade. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is stayin' alive.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 29, 2012, at 12:35 PM, rhealth wrote:

    I would hope that Fools reading this article have, by now, figured out better things to do with their money than MM mutual funds. Fool on!

  • Report this Comment On June 30, 2012, at 12:37 PM, topbeancounter wrote:

    My amateur investment account yields about 5% annually, and that's without too much thought. I bought Triple-A common stocks along with a hi-yield REIT that pays over 10%. Unless the bottom falls out of everything, I don't intend to do much more except to purchase other Triple-A stocks on a large correction, which doesn't look like it's going to be anytime soon, in spite of what the talking heads are says on the fair-and-balanced fear mongers on FOX.

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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