Rethinking Internet Savings Accounts After the New Money Market Fund Rules
New rules for money market funds that will take effect on Oct. 14 will fundamentally change the way money market funds operate. The new rules are intended to prevent runs on money market funds like what was seen in the 2008 financial crisis.
The most important change for retail investors is that prime and municipal money market funds may impose redemption fees or suspend redemptions during times of crisis.
Another change primarily affects only institutional investors. Prime and municipal money market funds that allow institutional investors will be required to maintain a floating net asset value (NAV). This means that you could lose money when you sell if the NAV has fallen from the time you had purchased the fund.
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U.S. government and Treasury money market funds are exempt from these new rules. A simple way for investors to avoid these new rules is to move their money into government money market funds. However, this might not be necessary since several brokerage firms have made this change for their investors. In December 2015, Fidelity's Cash Reserves fund, the world's largest money market fund, transitioned its investment strategy to become a government fund. It's now called the Fidelity Government Cash Reserves.
Whether you move to a government money market fund or your money market fund changes into a government fund, an important downside to consider is that yields will be lower. Government money market funds generally have lower yields than prime funds. As an example, Fidelity Government Cash Reserves has a yield of 0.12 percent. One of Fidelity's retail prime funds, the Fidelity Money Market Fund, has a yield of 0.38 percent.
The case for internet savings accounts. With the new money market fund rules taking effect, investors should consider moving their cash into internet savings or money market accounts at banks or credit unions. Both savings accounts and money market accounts are deposit accounts that are different than money market funds and aren't subject to these money market fund rules. A money market account at a bank or credit union is essentially a savings account. The only difference between the two is that money market accounts generally offer limited check writing privileges, whereas savings accounts don't offer any check writing privileges.
One benefit of savings accounts over money market funds is federal deposit insurance. A person's bank deposits are protected by the Federal Deposit Insurance Corporation (FDIC). Credit union deposits are protected to the same limit by the National Credit Union Administration (NCUA). Both the FDIC and NCUA are independent federal agencies that operate with the backing of the full faith and credit of the federal government.
Federal deposit insurance from either the FDIC or NCUA ensures that you won't lose money on insured deposits if your bank or credit union fails. The minimum deposit coverage is $250,000 per person and per institution. This amount can easily be increased within the rules of the FDIC and NCUA by establishing payable-on-death accounts with multiple beneficiaries.
The second benefit of savings accounts over money market funds is yield. Higher yields are available on savings accounts, though not all savings accounts boast higher yields. In fact, savings accounts at many brick-and-mortar banks will have lower yields than some money market funds. To receive higher yields, an internet savings account may be necessary. These are savings accounts that must be opened online at a bank or credit union. A recent study has shown that the average yield of internet savings accounts is more than four times the average yield of savings accounts at brick-and-mortar banks.
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Comparing the yield differences between the top money market funds and the top internet savings accounts demonstrates the yield advantage of internet savings accounts. Out of the top retail money market funds, Vanguard Tax-Exempt Money Market Fund is a leader with a yield of 0.59 percent. For internet savings accounts, Popular Direct from Banco Popular North America is a rate leader with a 1.26 percent APY.
Some downsides to internet savings accounts. Keeping your cash in an internet savings account rather than a money market fund can have some downsides. The time it takes to deploy the cash into a new investment, such as a stock or bond, could be delayed when money has to be transferred from a bank savings account to a brokerage money market fund. Investors should be aware of the withdrawal limitations and transfer times of their savings accounts.
First, all savings and money market accounts are limited in the number of withdrawals that can be done per month. Federal regulation limits electronic withdrawals to no more than six per statement period. Banks and credit unions will often allow an occasional withdrawal that exceeds the limit, but a fee will be charged.
Second, the electronic funds transfer (EFT) systems of internet savings accounts have delays and dollar limits. If you identify a trade that you want to make with your cash, you'll have to move those funds from the savings account to your brokerage account. The EFT time can be three or more business days. The exact time will depend on the bank. In addition, each bank sets its own dollar limit that caps the amount that can be transferred per day and per month.
Your brokerage may have an EFT system that's better than your bank's system, but that system will likely also have both delays and dollar limits. One alternative is to open an account at a brokerage firm that's part of a bank with its own internet savings account. Money can then be transferred without delays and dollar limitations.
Check your money market fund. If you're not sure if it's worthwhile to move your cash into an internet savings account, at the very least check with your brokerage firm about your current money market fund. Is it a prime or municipal fund which will have the potential of redemption fees and selling restrictions? Is it an institutional prime or municipal fund that allows the NAV to float, and thereby placing some of your principal at risk? If your money market fund has been transitioned into a government fund, how low is the yield?
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You might decide that the best combination of liquidity, safety and yield is an internet savings account rather than a money market fund.
Ken Tumin is the founding editor of The Bank Deals Blog at DepositAccounts.com, where he has been covering bank deals and deposit investment strategies since 2005. His insights are gleaned from DepositAccounts' patented rate-tracking technology and its community of fervent savers, along with his own decades of experience in investing in bank-offered savings products.
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