Low Risk, No Gain: It's Time to Dump Your Money Market Mutual Fund

Mutual fund performance
Mutual fund performance

Thanks to rock-bottom interest rates, it's harder than ever for cautious savers to get the income they need from their savings. Many have fled from safe vehicles like CDs to dividend-paying stocks in an effort to squeeze a decent return from their money, even though stocks carry the very real risk of losing principal.

For those who aren't willing to bet on stocks, the other options aren't very appealing. And one popular choice that investors have used for decades now faces a huge threat from the low-interest-rate environment -- a threat that could kill the industry.

Money Market Mutual Funds: A Dying Breed?

Last week, JPMorgan Chase (JPM) and Goldman Sachs (GS) announced that they were closing the doors of some of their European money market funds to new investors. The move came in response to the European Central Bank cutting interest rates on deposits to zero.

That may sound like a drastic measure to take. But in the U.S., many funds have had to take similar action to keep their funds afloat.

Over the years, money market mutual funds have attracted huge amounts of savings. In the U.S., they hold more than $2.5 trillion in assets, with about 35% of that money held in funds aimed at ordinary retail investors. Yet over the past three years, returns on those funds have averaged less than 0.10% per year, and recently, many of the largest funds in the business have been paying just 0.01% in interest.

The cause of those low rates is the Federal Reserve's long-held policy of keeping short-term interest rates locked between 0% and 0.25%. In addition to chopping rates to virtually nothing, many funds have also had to respond by cutting fees and refusing new investors in order to prevent losses for existing fund investors.

Funds Under Siege

As if that weren't bad enough, money market mutual funds have also attracted attention from government regulators.

As The New York Times reported last month, the Securities and Exchange Commission believes that the funds are vulnerable to a potential repeat of the financial crisis four years ago.

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Back in 2008, the bankruptcy of Lehman Brothers caused significant losses for many of the money market funds that held the brokerage firm's commercial paper. One fund, the Reserve Primary Fund, suffered such large losses that it "broke the buck" -- industry jargon for falling below its stable $1 per share price.

Although that's an extreme case, the SEC put forth evidence that smaller losses have occurred regularly throughout the history of money market funds. By its count, fund managers have had to bail out funds from losses more than 300 times in the four decades that the funds have been in existence. Without the bailouts, fund investors might have had to eat losses, despite the funds' reputation as safe places for savings.

The SEC has proposed several possible ways to prevent similar problems in the future. Among them are letting share values of money market funds float up and down rather than remaining fixed at $1, as well as forcing funds to put policies in place and have capital reserves ready in the case of massive withdrawals.

Opponents of such measures argue that such a move could itself cause a run on the funds, which in turn could destabilize the short-term credit markets that major companies rely on for day-to-day operational financing.

Get Smart: Get Your Money Insured

Regardless of what happens with the SEC, though, savers have a much more attractive option for their money. Several banks offer high-interest savings accounts that pay significantly higher rates than most money market funds, with the top rates near or above 1% currently.

Admittedly, 1% isn't much. But it also comes with something money market funds don't give you: the safety of FDIC insurance for up to $250,000. With the combination of greater security and more money in your pocket, high-yield savings accounts make more sense than ever right now.

As for money market funds, there may come a time when their rates become attractive again. For now, though, there's really no good reason to have your money in them.

Motley Fool contributor Dan Caplinger has gotten just about all his money out of money market funds. You can follow him on Twitter here. He doesn't own shares of the companies mentioned. The Motley Fool owns shares of JP Morgan Chase. Motley Fool newsletter services have recommended buying shares of Goldman Sachs.

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