Stern Advice: Don't toss that money fund out with the trash

WASHINGTON (Reuters) - Wall Street hotshots have long disparaged money market mutual funds with a “cash is trash” epithet. Their point: Money invested in these funds earned low returns and wasn’t being put to use in more rewarding stocks and bonds.

Four thousand U.S. dollars are counted out by a banker counting currency at a bank in Westminster, Colorado November 3, 2009. Picture taken November 3, 2009. REUTERS/Rick Wilking

Money funds have seemed even less appealing in recent years. Their long-cherished and promoted practice of holding their share price steady at $1 got blown at the end of 2008, when the Reserve Primary Fund’s inability to meet redemptions in a dysfunctional credit market caused it to drop the price to 97 cents a share.

Since then, regulators and industry players have been talking about ways to make money funds more safe but, so far, most of that is still at the mulling-it-over stage.

Did I mention that money funds are now yielding between 0.03 and 0.07 percent, according to Crane Data? “That means it would take between 600 and 900 years to double your money,” says Peter Crane, the firm’s publisher.

But, wait. Money market mutual funds have their purpose, and their rewards. It’s just that you may have to think about them differently now than you did before.

Here are some tips:

-- Don’t bother reaching for yield. As Crane points out, money market funds are yielding such spectacularly awful returns that it’s not worth moving from one fund to another just to eke out a few more cents a year. And what if you find a money fund that’s yielding significantly more than the rest? “Anyone that needs the money that badly isn’t someone you should be doing business with,” he says.

-- Buy them for convenience sake. If you want to keep some cash handy for buying stocks and bonds in your brokerage account, but you’re not quite ready to do that buying yet, there’s no better place to keep your cash than a money fund. Make that the money fund that your brokerage firm keeps especially for that purpose, says Crane. There’s no point in using another money fund that will take three days to transfer your funds once you are ready to trade.

-- They are safer than they were. One year ago, the Securities and Exchange Commission did strengthen money funds, requiring them to keep higher percentages of their assets in very liquid investments. Funds now have to hold at least 10 percent of their assets in instruments that could be liquidated in a day, and 30 percent in investments that can be converted to cash within a week. “That doesn’t get as much credit as it should,” says Crane. “It has certainly improved the safety of money funds dramatically.”

-- There’s more where that came from. Federal regulators are mulling other changes, and have floated the idea that money funds should let their share prices float. That isn’t likely -- the SEC is currently sitting under a pile of comments from all corners of the industry, saying that would be a huge fund-killing mistake. Instead, it’s possible that the fund industry -- organized by its trade group, the Investment Company Institute -- would create its own backup fund to bail out one of their own if it got into Reserve-like trouble.

-- Look at bank accounts as an alternative. If you want to park money in a fund for a while, consider comparable money market deposit accounts run by banks. They aren’t quite as mobile; it can take days to move money from a bank to your brokerage account. But they are FDIC insured, and they are offering higher yields -- 0.6 percent and up, according to Bankrate.

-- Be nimble, because money market funds will be in the sweet spot soon. As soon as rates start rising, a money market mutual fund is going to be a great place to put some cash. That’s because they do respond quickly to market rates; you’ll keep your cash safe and watch your yields rise. The last time the Federal Reserve started raising rates, in 2005, it raised the discount rate by 25 basis points (0.25 percentage points) every time its policy-setting committee met -- for two years straight. It moved from 1 percent to 5.25 percent in two years. Many Fed watchers believe that could start again before 2011 ends. If it does, your money market mutual fund won’t be trash at all. It will be golden.

editing by Gunna Dickson