Triple the Returns on Your Savings and Get Safer, Too.

Last Updated Apr 26, 2010 2:09 PM EDT

EVERYBODY HAS A MONEY MARKET MUTUAL FUND. It's the ultra-safe place you park the money you absolutely, positively can't put at risk-like the house down payment you need to make next month-and the place you hold money until you make up your mind about what you want to do with it for the long run. Indeed, you may well now have more of your cash in money market funds than ever, because in a dangerous world, money funds are among the few perfectly safe hiding places.

Problem is, money funds are not perfectly safe. Even more of a problem, logically speaking, is that they return a fraction as much as some alternatives that are perfectly safe. The laws of markets dictate that riskier investments yield more, safer ones less. That law doesn't hold in the case of money funds, which suggests something irrational is afoot.

Let's start with the safety question, and the sleight-of-hand that underlies all money market funds: They are structured to give the impression that they are the equivalent of cash in the bank, but they are not. Like other mutual funds, they invest in marketable securities-in this case commercial paper, Treasury bills, asset-backed securities and other tradable short-term debts . However, money funds enjoy a special dispensation, unique in mutual fund regulation, to price shares at a constant $1, as if the underlying assets never fluctuate.

The assets do, of course, fluctuate in value, but money funds are allowed to disguise the fact. The façade of the invariable $1 share holds up only as long as markets are functioning smoothly and the fund doesn't stumble onto a security that gets into trouble-or if the fund's sponsor is willing to make you whole for any bum investments. That's usually safe enough, but that's not the same as absolutely, positively safe. Ask shareholders in the Reserve Primary money fund, which lost 3% of its value in September 2008 when the fund chose not to make good on its managers' ill-timed investment in Lehman paper. (The fund is now in the process of liquidating its few remaining assets.)

For most of the past few decades, you were paid well for taking the risk of a black swan event like September 2008. Not these days. Money funds can't yield more than the securities they own, minus operating expenses, and the Federal Reserve is keeping interest rates on money market securities at microscopic levels (and repeatedly promises to keep them there "for an extended period.") The typical money fund yields a laughable 0.03 percent. You might as well not even bother.

The only absolutely, positively safe investment is a federally insured bank or credit union savings account (at least up to the limit of federal insurance, which is $250,000 through the end of 2013). And unlike a money fund, banks and credit unions can pay whatever they believe they can make a profit on, subject to regulations. That is a license to eat money funds' lunch. For example, Jeff Davis Bank and Trust now offers a savings account with a yield of 2%. The bank is covered by the FDIC and holds five-star "safe and sound" rating from lists a dozen other banks and credit unions paying 1.3% or better.

So you could increase the yield on your cash 65-fold to 100-fold and make it safer to boot. Or to put it another way; with a $100,000 account, you can earn an extra $1,998 in a year for picking up the phone and making your money absolutely, positively safer. And the reason you're not doing this is...what, again?

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  • Eric Schurenberg