The Bureau of Economic Activity recently reported that in July, the U.S. personal savings rate dropped to -0.9%. In fact, that figure has been negative for 14 consecutive months. So be forewarned: We're going to talk about a very unfashionable topic among Americans these days -- saving money.

The piggy bank
Cash belongs in every portfolio. For those living off investment income, cash investments provide certainty for short-term spending requirements. For more aggressive investors, whose portfolios have decades of growth remaining, cash holdings are a necessity when they're waiting for a specific buying opportunity. And every investor, young or old and regardless of investment strategy, should have a rainy-day fund set aside for unemployment, medical emergencies, and other unpredictable situations. This fund should contain at least two months of current income, held in a separate cash account.

Economics of cash
Now the downside: Since cash is nearly risk-free, you can't expect much of a return. The average American savings account pays only a 0.54% APR. But I suggest that you deserve a far better return on your cash over what the traditional bank pays. After all, the bank is investing your deposited cash into short-term, risk-free bills and paper, and it's earning close to 5% in the current rate environment.

So why don't you earn 5% when you drop off your savings at the bank? The answer lies in the overhead. The building, the tellers, the checks, and the stale candy -- this stuff all costs money. To cover all of those expenses, the bank pays you less interest than it earned on your cash. And in the case of savings accounts, it pays you far less.

Finally, an Internet business that makes sense
ING (NYSE:ING), a global banking and financial-services company, went out on a limb and launched the first major direct Internet banking operation in 1995. Originally in Canada, the ING Direct program rapidly expanded to other countries as the business model virtually sold itself. ING Direct had none of the overhead of a traditional bank, since all transactions were handled online, over the telephone, or by mail. There were no costly buildings or people hanging around and driving up expenses. There were no checking accounts. There weren't even any ATMs. There was just cash savings.

With such an efficient cost structure, ING Direct was able to profitably offer one of the highest rates of return on cash savings. As a result, while other bricks-and-mortar banks are still paying 0.54% interest, ING Direct today offers 4.4% APR on cash savings -- no minimums, no fees, and your deposit is FDIC-insured up to $100,000. With today's flat yield curve, why risk locking your money into a bond or certificate of deposit when you can make 4.4% on overnight cash savings?

ING Direct has spawned a number of clones, and most offer great rates and customer service, provided you don't need the comfort of a real bank teller. Emigrant Direct, the direct bank of Emigrant Savings Bank, New York, offers 5.15% on cash savings. HSBC Direct, run by HSBC (NYSE:HBC), pays 5.05%, and Lydian Virtual Bank's e-Money Market account pays 4.6%. No minimums, no fees, and user-friendly online account access.

By linking one of these savings champs to your checking or brokerage account, you can easily shuttle money back and forth, so that it earns real interest while you aren't paying bills or executing transactions with it. If you really want to work your cash, you can open online accounts at several of these direct banks and then transfer your holdings to wherever the highest interest rate happens to be.

Move over, money market mutual fund
These direct banking accounts are so efficient and simple that they might just replace one or two of the mutual funds in your portfolio. If you've been keeping your cash allocation in a taxable money market mutual fund, consider using a direct-banking savings account instead.

For example, at ING Direct, over the past year ended in August, you would've earned 4.1% on your cash, paid no expenses or fees, been subject to no minimums or trading costs, and had FDIC insurance. Compare that cash investment with the PIMCO Money Market B, which earned 3.64% over the same period. It's also subject to a 0.12% management fee, and a 1% 12b-1 fee, for a 0.95% overall expense ratio. What's more, you're subject to minimum investment levels (in this case, $5,000) and possible trading costs if the fund is held through your retail brokerage account. All that hassle for only a 3.64% return? And there's no FDIC insurance, since a mutual fund isn't covered.

At first glance, the Liquid Assets Money Market/Morgan Fund from JPMorgan Chase might look pretty good, with its 4.13% return. But after adjusting for fee and load expenses, that return drops to 3.82%. And there are far worse returns than that in the world of money market mutual funds. MFS Cash Reserve B offers liquid investments in U.S. and foreign assets, but it returned only 3.16% over the past year, and its expense ratio was a staggering 1.49%.

Sure, within a conservative IRA or 401(k), money market mutual funds can still serve a purpose, since your cash investment vehicles are rather limited. And if you're looking for tax-exempt cash investments, a municipal money market fund is still the best way to go. But for cash investments in your general brokerage account, you can do far better than putting money with a manager who charges 1.5% to purchase three-month Treasury bills.

Cash isn't that difficult. Deposit it, forget about it, earn interest on it, and then spend it or invest it when the time is right. With one of the direct savings accounts we've discussed here, you can outperform money market mutual funds, and you can probably even find a few incentives for new accounts at the direct banks. ING Direct, for example, paid bonus interest on new deposits during a "Winter Save-Up" special last year. That sure beats paying load fees for a new mutual fund account.

But don't take my word for it. Run a mutual fund screen on money market-style funds. The returns are equal to or worse than what you can get on your own in a direct-banking savings account. And in terms of flexibility, there is no comparison -- the direct-banking option is simple, free, and FDIC-insured. And when saving money comes back into style, you'll be ahead of the pack.

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This article was originally published on Sept. 20, 2006 by Ryan Popple. It has been updated by Joey Khattab, who does not own any of the shares mentioned. Feel free to check out the Fool's disclosure policy.