Everyone who has a bank account knows just how terrible interest rates have been for a long time. Just as hard-hit savers have had to flee elsewhere to find the income they need, so too have financial companies that offer money market mutual funds had to eat losses. Now, changes at the Securities and Exchange Commission could reinvigorate past efforts to reform money market mutual funds, and those efforts could well lead to changes that will make the funds useless as places to stash your spare cash.
Later in this article, I'll point you to some better places to put your money. First, though, let's take a closer look at money market mutual funds to see where they've been and where they may be headed.
The beauty of interest
Ironically, money market mutual funds originally came about as a way to get better returns on your money than bank accounts offered. Due to bank regulation, banks typically paid less in interest to their accountholders than you could get from Treasury bills, commercial paper, and other equally liquid short-term fixed-income investments. Especially during periods of high inflation, money market mutual funds made it possible for savers to keep their savings from losing too much of its purchasing power.
But ever since the Federal Reserve implemented its near-zero interest rate policy, money market mutual funds have had a big problem. Ordinarily, like any other mutual fund, money market mutual funds take their expenses out of the earnings that their assets produce. When those assets are only able to produce tiny amounts of income, though, it's sometimes not enough to cover the funds' expenses.
Passing those expenses on to shareholders in the form of losses would be one option. But because the general public sees the $1 per share net asset value of money market mutual funds as inviolate, any move that would "break the buck" and reduce net asset values would lead to a huge run on the funds. That's what happened in 2008, when the Reserve Primary Fund held Lehman Brothers debt that plunged in value when the company filed for bankruptcy.
Some companies have taken the opportunity to give up on the business. Legg Mason (NYSE:LM) liquidated $23 billion in funds back in 2010, while SunTrust (NYSE:STI) ended up selling its fund line to money market giant Federated Investors (NYSE:FII).
But those departures may seem trivial compared to what could happen if SEC proposals to reform the funds are eventually approved. Earlier this year, the SEC's then-chair Mary Schapiro suggested a set of possible remedies to structural concerns about the funds. The suggested solutions included allowing fund prices to fluctuate, requiring funds to set aside capital reserves to handle mass redemptions, or forcing fund shareholders to sit through a waiting period if they wanted to cash out their accounts.
Two things have happened recently that could push things forward more quickly. Schapiro is leaving the SEC, raising the possibility that she may want to try to get this taken care of before she goes despite the fact that incoming chief Elisse Walter is expected to follow Schapiro's general plan. More important, though, the SEC's staff gave its commissioners a report that analyzes the proposals. In response, some of the commissioners who initially opposed the proposals may now be more open to them.
Companies that run the funds have fought the proposals. Effectively, they argue that the changes could well bring on the cataclysmic events they're supposedly designed to prevent.
But as I've noted for years now, there's little reason to own money market mutual funds now. Right now, FDIC-insured savings accounts from SLM's (NASDAQ:SLM) Sallie Mae as well as Barclays (NYSE:BCS) pay 1% or more, versus yields closer to 0.01% for most money market mutual funds. You can also access short-term investments like Treasury bills directly through the government's website or indirectly by participating through discount brokerage programs.
The best way to survive any potential change to rules governing money market mutual funds is to get your money to a better place now. Not only will you avoid any regulatory problems, but you'll earn more income to boot.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.
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