Money market accounts stay hooked to Fed

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If the economy continues to improve, money market funds have nowhere to go but up.

But don’t hold your breath waiting. Money market accounts hold very short-term investments and their yields mirror short-term interest rates, which the Federal Reserve has promised to keep exceptionally low for an extended period of time.

The rate policies from the Fed only account for part of the stagnant rates, however.

Following the collapse of Lehman Brothers in September 2008, up to 36 money market funds nearly “broke the buck,” according to a report last August by Moody’s. Breaking the buck means a fund can’t ensure clients get back at least one dollar for each dollar they put in.

Only one fund did end up dipping below the required $1 per share of net asset value: the now-infamous Reserve Primary Fund, which held $785 million in Lehman-issued securities and became unable to meet investor requests for redemptions. In early 2010, The Securities and Exchange Commission announced that the fund’s investors had recovered roughly 98 cents on the dollar.

The fallout from that catastrophe included stricter investing guidelines for money market funds imposed by the SEC. As of May 2010, money market funds must invest in high-quality, very short-term investments as well as keep a percentage of the fund in highly liquid investments, such as cash and securities that can be quickly converted to cash.

If it sounds like a recipe for an extremely low rate forecast, it is.

“An improvement in money market yields is not on the horizon,” says Greg McBride, senior financial analyst at

They will not improve “both because the Fed is going to keep short-term rates low as far as we can see and because of the stricter requirements on what money funds can hold,” he says.

In normal economic times, money market accounts afford investors a safe place to park their cash, typically with a slight yield bonus over savings accounts or federally-insured money market accounts offered by banks.

When inflation finally does light a fire under the rate-setting committee in the Federal Reserve, money market funds may be more affected than other interest-bearing instruments, according to Dave Katz, principal and senior portfolio strategist at Weiser Capital in New York.

“There’s a lot more room for them to run, I think they’re paying virtually zero now,” Katz says.

Despite bottom-of-the-barrel yields, investors still make use of money market funds, though perhaps not quite in the numbers of previous years. The Investment Company Institute reports that as of Jan. 5, 2010, money market fund investments for retail and institutional investors totaled $2,797 billion. That’s down nearly half a billion dollars from last year at this time.

Unfortunately, investors have very few options these days for parking their money. The yields on money market funds may make some investors queasy, but the only alternative is to take on more risk than they might otherwise care to.

Bankrate has a comprehensive analysis of where all sorts of interest rates are likely headed in 2011, and how these moves will affect you. Visit our 2011 Interest Rate Forecast to view the full report.

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