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Keep your money fund or dump it?

It's no secret that interest rates for money market funds are scraping bottom. Even the top recommendation in our current money rates table (subscription required) is paying a scant 0.30%. Vanguard Prime, one of the best-known and most popular MMFs available, is yielding a barely noticeable 0.05%.

So is it time to abandon the money-fund ship and move your savings elsewhere?

Russel Kinnel, editor of Morningstar's FundInvestor newsletter (and director of the company's mutual fund research), is advising MMF investors to hang on rather than bailing on MMFs and moving to short-term or ultrashort bond funds.

We're still wary of ultrashort funds [following the implosion of several such funds in 2007 and 2008]. Short-term bond funds can work if some losses in the short run are acceptable — for example, if you are parking money between investments, plan to hold for a year or two, or just want a conservative bond holding in your long-term asset-allocation scheme....

But for other uses, such as emergencies or upcoming big-ticket expenditures, I'd stay with money market funds. Think about what will happen when interest rates start to rise. Bond funds will initially lose money because their superlow-yielding bonds will be discounted in the face of new higher-paying bonds. On the other hand, money market funds will quickly start to have higher yields, yet they won't lose money when rates go back up.

Kinnel concedes that MMFs aren't exciting, "but money market funds are there to serve in an emergency. Insurance always costs you money, and that's how I'd look at money markets."

Another practical matter is simply: Is it worth the trouble to switch? A Los Angeles Times story (titled, "Look, Ma, Nearly No Yield") quotes Peter Crane, head of money-fund research firm Crane Data: "My general rule is, if you're not going to make $100 more [in interest] by switching, don't bother."

Although 2009 was the toughest year on record for money funds, the MMFs recommended by SMI outperformed the overall field (for the 12th year in a row). Details are available for SMI web members in our February Level 2 article.

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