Move your savings from a money market mutual fund to a one-year bank CD, and you'll earn enough interest to buy a new tent for your flea circus — but not much more.
At these rates, it's a good idea to ask yourself why you own a money fund. Even at today's rates, money funds are a good tool for reducing risk in your portfolio. But if you're looking for income or just stashing some cash, you'd be better off elsewhere. The average money fund yields 0.06%, according to iMoneyNet, which tracks the funds. That's $6 a year on a $10,000 investment. At that rate, you'll double your money in 1,200 years.
You could, of course, move to a fund with an above-average return. Among money funds available to individuals, Waddell & Reed Advisors money fund has the highest yield: 0.78%, or $78 a year on a $10,000 investment. While not a pittance, it will still take a century to double your money at that rate.
Money funds aren't just being stingy: They invest in short-term, high-quality IOUs and pass the proceeds to shareholders, minus expenses. Unfortunately for savers, the Federal Reserve Board has pushed short-term interest rates to nearly zero. In fact, dozens of money funds now yield exactly zero, because their expenses eat up all their interest.
So what should you do? Start by thinking about why you have money in a money fund. Here are two good reasons:
•Asset allocation. You may have money in a money fund as a way to hedge against stock market declines, and there's nothing wrong with that. If you had kept 30% of your portfolio in money funds and 70% in the Standard & Poor's 500 index the past decade, you'd have gained 2.8%. Nothing to brag about, but the S&P 500 lost 9.9% the same period.
You would have fared far better had you put 30% in a general U.S. government bond fund — a traditional way to reduce the risk of owning stocks. Your portfolio would have gained 14.1% the past decade.
You might be better off using a money fund as a hedge the next 10 years, however. Bond prices fall when interest rates rise — and with rates at their lowest in decades, it's a good bet that rates will be higher in a decade. In that environment, your money fund won't lose money, but your bond fund will.
•A buying reserve. It never hurts to have cash on hand, and in most cases, a money fund is the handiest place to keep cash for investment purposes. Keeping 10% of your portfolio in a money fund won't detract from your performance that much in a bull market, and it will come in handy during a market decline.
But there are two good reasons to dump your money fund, too.
•Short-term savings. If you plan to use your money in the next one to three years, you need to have it in a short-term savings account. True, you might be able to earn more money in stocks or bonds. But if you need a set amount of money at a certain time, then don't take the risk. You don't want the stock market to determine what size house you buy, or when you get your next new car.
Right now, you have better alternatives than money funds. You can, if you like, move to a higher-yielding savings account. For instance, Tennessee Commerce Bank offers a money market account yielding 2.28%, according to Bankrate.com. It's not a fortune, but it's better than 0.06%.