Top Alternatives to Money Market Mutual Funds
Money Markets Aren't the Only Place to Park Your Surplus Cash Reserves
While both money market accounts and money market funds - they are different in that one is a type of mutual fund that invests in certain cash equivalent and fixed income securities while the other is a type of FDIC-insured bank account that pays interest - can be a great place to park your surplus cash reserves, there are alternatives to money markets, some of which offer more ideal terms and yields depending upon your specifics needs and investable assets.
Which of these alternatives is most appropriate for your given situation is going to depend upon a number of factors but I want to walk you through a few of the pros and cons to help you better understand your options and opportunity costs.
The First Alternative to a Money Market Is a Plain-Vanilla Savings Account
It might sound old-fashioned but there are times, for certain situations and at certain moments, when nothing beats a passbook savings account. I went through some of the benefits with you in an article I wrote called 5 Things To Look for in a Savings Account. You get instant access to your funds, the backing of the FDIC in the event of a bank failure, and the convenience of a local branch office. Unlike a money market fund, there is no chance of a savings account "breaking the buck".
The Second Alternative to a Money Market Is a Certificate of Deposit
The differences between these two asset types were important enough, I talked about them specifically in an article called Certificates of Deposit versus Money Markets.
Certificates of deposit, or CDs as they are often called for short, are fixed income investments that involve you lending money to the issuer (the bank) for a predetermined length of time - e.g., 3 months, 6 months, 1 year, 2 years, 5 years, 10 years - in exchange for a fixed yield. Usually, under most interest rate environments, the longer you are willing to lock up your money, you higher the interest rate you are guaranteed.
As with savings accounts, CDs are insured by the FDIC up to the in-effect limits, though you can often extend those limits to as high as $1.25 million through the use of techniques like using payable-on-death designations.
The Third Alternative to a Money Market Is a TreasuryDirect Account with the U.S. Treasury
If you are wealthy enough that you exceed the FDIC insurance limits and don't want to deal with multiple banks, there is only one place you should seriously consider parking your cash reserves if you aren't satisfied with the risk trade-off of money markets. That is a TreasuryDirect account with the United States Treasury Department.
TreasuryDirect accounts not only boast some of the highest security in the financial industry, they invest in sovereign bills, bonds, and notes issued by the United States Government and backed by that same government's unlimited taxing power and constitutional obligation to repay its liabilities. It is often the only place many rich investors and corporations will consider parking their surplus funds.
The Fourth Alternative to a Money Market Are Short-Term Bond Funds
You already know the difference between investing in bonds and investing bond funds.
The right short-term bond fund, while introducing some risks, can be a decent alternative to money market funds and might even boast a higher yield. Whether or not this is a reasonable or intelligent decision at any given time will depend upon the facts.
For example, as I re-write and update this article on May 3rd, 2016, years after it was originally published on June 28th, 2012, I see that something like the Vanguard Short-Term Bond Index Fund has an SEC yield of 1.08% with an average duration of 2.7 years on the bonds held within the fund. Meanwhile, you can get 2 or 3 year FDIC-insured certificates of deposit yielding anywhere from 1.05% to 1.50%. The certificates of deposit are a wiser choice. You're getting more for your money; more yield, arguably more safety. It's always changing so you have to check market conditions.
The Fifth Alternative to a Money Market Is a Fixed-Income Focused ETF
The newest competitors to money market funds are special types of exchange traded funds launched by certain asset management firms that seek to combine a capital preservation mandate with maximum liquidity. A well-known example of this is the PIMCO Enhanced Short Maturity Active ETF, trading under ticker symbol MINT. Over the past 5+ years, it has fluctuated from a low of $99.89 per share to a high of $101.65 per share. The expense ratio is 0.36% and the SEC yield is 1.44% with a distribution yield of 0.88%. Even better, it is not a leveraged ETF, which I think most investors should avoid like the plague.
Again, these are not without their risks. Honestly, I'd most likely prefer a money market account, certificate of deposit, or TreasuryDirect option myself but different investors have different values, risk tolerances, and priorities. I favor safety of principal over everything when it comes to cash in a portfolio because I am reminded of the warning of Benjamin Graham who said something along the lines of, "More money has been lost by investors reaching for a bit of extra yield than stolen at gunpoint". I want the funds to be there in case I decide I need them or an opportunity presents itself to invest in attractively valued stocks, bonds, mutual funds, real estate, or other asset classes.