Money Market Alternatives

If you have cash sitting in a money market mutual fund right now, chances are the yield is quite pitiful. Have you checked recently? The average yield on a money market fund is only 0.09%! Even the usually competitive Vanguard Prime money market fund (VMMXX) is only paying a 0.23% yield, and the highest paying retail Fidelity fund is eeking out a 0.44% yield. (Numbers as of 8/3/09.) There’s little if any benefit to switching to a Treasury or Municipal money market fund, either.

Such low yields may tempt you to start looking at corporate bonds or funds with longer maturities. However, by chasing any of these you start risking your principal. Definitely avoid anything with “high-yield” in the name for your cash needs. Why not explore the world of FDIC and NCUA-insured deposits? The new $250,000 insurance limits per titled accounts are now extended through 2013.

High-Yield Reward Checking Accounts
These are checking accounts, usually through local credit unions, that pay a very high interest rate if you jump through some hoops each month. However, if you make a mistake you’ll forfeit virtually all your interest for that month, so it can be tricky. In addition, these accounts also only pay the higher interest on a limited balance, usually $10,000 or $25,000. But for the very diligent, their rates are still averaging around 4-5% APY on balances up to $25,000. Here’s one recent example at 4.01% APY that requires 10 check card purchases each month, a direct deposit/auto-withdrawal, and online statements.

For more, see my review of rewards checking accounts and also a list of participating banks by state here. I’d stick with small local banks with limited membership eligibility if possible, the rates tend to be more stable.

Online Savings Accounts
With most online brokers these days, you can easily link your accounts to online banks and make direct funds transfers. Online savings accounts like FNBO Direct or Ally Savings offer $250,000 of FDIC-insurance and easy liquidity. You’ll likely get a yield that is at least 100 basis points (1%) higher than any money market fund. However, you are limited to a maximum of 6 withdrawals per month.

Bank CDs & Short-Term Promotions
If you have a large amount of money to invest, and you don’t need immediate access to the funds, you can still get around 3% APY for short periods of time. For example, Everbank is offering 3.01% APY for the first 3 months for new accounts. WT Direct has a promotion that can earn you 3.2% APY for a 2.5 month commitment. To me, a short-term promotion is the same thing as a bank certificate of deposit, since many banks offer nice rates and then drop them when up for renewal.

When you’re done with the term, perhaps money market mutual fund rates will be tolerable again!

Comments

  1. HS @ Our Debt Blog says:

    We took around 10,000 from our FNBO Direct account and opened an account with Scottrade. I do a couple of trades per month an attempt to earn at least 5%, this is a little bit more risky but much better than the 1.5% from FNBO. Apple was good to me this month! I made 135!!

  2. HS, so you are saying that you are trying to time the stock market to bump your gains to 5% a month? That’s a very risky prospect. It may have worked this last month but take a look at what most likely would have happened to you on October 2008! The stock market is good for long term funds (5 to 10 years or more); but not good for emergency cash.

    To increase my savings returns on cash that I might need in the next 1 to 5 years I have a mixed portfolio of pretty conservative bond funds and an online savings account.

    25% Zions Direct Bank (1.45% APY)
    37.5% Vanguard GNMA Bond Fund (VFIIX)
    18.75% Vanguard Short Term Federal (VSGBX)
    18.75% Vanguard Short Term Corporate (VFSTX)

    These are all pretty low risk funds but have the potential of our performing an online savings account. Does anyone else have any thoughts on this?

  3. I agree w/ cayden. short term bond funds get short shrift as a parking place for cash. have gotten annualized return of 5.61% over the last year in T. Rowe Price’s Short Term Bond fund (PRWBX). have lost zero principle (was down for 2-3 months through last fall’s market gyrations, but has recovered nicely).

  4. Great info, Jonathan. This is the kind of thing that I read this blog for. I’m a low-maintenance investor, and I usually assume that Vanguard money market is going to be near the top rates for holding cash, so I don’t even bother checking. Thanks to your info, I’m going to move my Vanguard MM to Presidential savings instead (1.5% FDIC insured).

  5. This is a very timely topic, thanks for the tips. I am of the opinion that the market will have a pullback soon and am researching for a temporary place to park my funds, mainly the ones you guys mentioned. I also looked at the Vanguard Wellesley fund. Not quite sure yet. Any opinions on this?

  6. GNMA bonds have their own risks, but is not bad for long-term income fund in my opinion. If mortgage rates start to rise the maturity will lengthen and you’ll be stuck with the current low rates (less refinancing.) I wouldn’t use it for cash. I also don’t own any GNMA bonds at all currently.

    I personally like Wellesley a lot, it has a really low expense ratio so even though it is actively managed the drag is small. Again a good income fund where you don’t care about NAV/principal as much, but wouldn’t use it for cash.

    Just remember you might still lose 5% or 10% in one of these funds over a year, which might be acceptable to you but to me is not what I expect from cash.

  7. Correct me if I’m wrong on this but won’t all of these bond funds be hurt when and if interest rates start to rise?

    I recently read something on that said Vanguard’s TIP mutual fund won’t really help you in the case of rising interest rates and inflation. This author projected that the principle loss due to the increase in interest rates would be greater than the bump you get from the inflation increase. That’s the problem with holding bond mutual funds as opposed to actual bonds. When interest rates rise, your principal goes down. You end up with a negative return yet you still have to pay tax on the dividends you received.

  8. I personally prefer GE Interest Plus [http://www.geinterestplus.com/index.html] for keeping my cash. The current APY for balances under $15,000 is 2.02%; $15,000 to $49,999 is 2.17%; $50,000 or over is 2.32%. I have my bills paid via autopay via ACH with this account, and I can write checks if they’re $250 or more. GE Interest Plus is not FDIC-insured, but neither are money market mutual funds. Also, it has consistently paid a higher interest rate than money market mutual funds have. You can also withdraw or invest money via ACH for amounts of $25 or more.

  9. Here are some more resources — Ing Electric is at 1.60% for accounts over $50,000. TD Bank has a 60 mo CD at 3.00% min. $500.00

  10. discover bank is offering 2%? Have you looked at it?

  11. I am with the short term (corporate) bond camp. Yields are much higher than cash right now. Especially when you factor-in expenses. Remember that the Vanguard Money Market’s current expense ratio is 0.28%, which erodes the current yield.

  12. Credit unions are not covered by FDIC so that makes me nervous. What do you guys think?

  13. Smartypig.com is still the highest savings rate anywhere I’ve seen, currently at 2.75% APY and is FDIC insured. Ever since I opened my account there I haven’t seen anything else beat it.

  14. The 3-month T-bill (equivalent to cash) is at .16% right now, which is a good benchmark for money market rates. If Smartypig.com or other issuers are offering much higher yields, then I would dig to find out what they are invested in. Anything higher than the benchmark is going to include a risk premium.

  15. I’m wondering if Smartypig.com is truly insured by the FDIC. While their accounts may be held in an FDIC bank, what is to stop the business itself from going under. It’s like you lend me $5k, and I put the money in an insured bank, but then my business goes belly up and so does your $5k even though I had the money in an insured bank. Something doesnt look right with this….

  16. I don’t think Smartypig is an actual financial institution. They work with West Bank (http://www.westbankiowa.com/), which is FDIC insured. Although the 2.75% APY seems like a high yield, I don’t think it’s a good apples-to-apples comparison with the money market funds Jonathan mentioned initially because Smartypig is based on a savings goal program. That is, the participant sets an amount they contribute each month and they cannot make partial withdraws. In my mind, this defeats the flexibility of liquidity that we are all looking for.

  17. WFR71 Says: “Correct me if I’m wrong on this but won’t all of these bond funds be hurt when and if interest rates start to rise?”

    Of course! Vanguard GNMA fund may be decent for long term bond allocation, but it’s certainly not the best place for short term cash. The average maturity of holdings is 3-10 years.

  18. @cayden: bond funds are not bonds. They don’t come with a maturity date. Hence, they can lose value. As soon as interest rates start going up, the value of ALL bonds in your bond funds will drop. Bond funds aren’t risk-free – yes, the risk of default is low than in individual bonds because of diversification, but you have no option of waiting to maturity if the bonds lost their value because of interest rates.
    @PMF – the reason you lost 0 principal is that the interest rates weren’t going up.

    BTW – my bonds are up as well. I have several individual bond issues – corporate and municipal – that have done quite well. I could’ve sold them now with profit, but since the interest rate relative to current balances still look attractive I am holding on. If they go up enough that yield drops, I’ll sell. Now though, the bonds aren’t that cheap as much as they used to be. I bought my issues at a discount, but all of them are now selling at a premium. The yields on short term individual bonds, at least AA and AAA bonds is not better than on CDs. Medium and longer term still look good, but one needs to be aware of interest rates.

    I have some bond funds in my 401K, but I’ll move out of those as soon as I feel the rates turn. In my taxable accounts I prefer individual bonds. Granted, not everyone has enough money to invest in individual bonds, but one still need to understand the difference between bonds and bond funds.

    Bucky – since you don’t have option of holding to maturity i.e. getting your principal back at certain date, your fund can lose value long term as well.
    @John – credit unions are insured by NCUA, so I think they are pretty safe.

  19. You indeed cannot make partial withdraws of funds in Smartypig. The only thing you can do is withdraw the full amount of a savings “goal”. But if you’re like me and don’t go dipping into your savings on a regular basis and just let it sit, then it’s ok. If you need the money, you can close the goal and you’ll have your money back after a standard 3 or 4 business day ACH transfer.

    You can establish multiple goals at the same time. The downside is that you must contribute an amount monthly to each goal. This can be a small amount as little as $20. I have not gone lower than that. In the long run though, I see nothing wrong with this mechanism as it helps me to save even more.

  20. @John –
    Credit unions come under the National Credit Union Administration, a US government agency parallel to the FDIC. The same $250,000.00 federal insurance applies to any money you hold in a credit union that is covered by the NCUA.

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