Banks Trounce Money-Market Funds

Deposit accounts offer higher rates -- and a guaranteed safety net.

If you're looking to earn the highest interest rate on your stash of cash, a bank is your best bet. Some banks are paying more than 2% on their money-market deposit accounts, while taxable money-market mutual funds yield an average of only 0.12%. Plus, your savings are insured up to $250,000 per account, at least through December 2013.

For example, with a minimum deposit of just $100, you can open an Advantage Savings Account with the Bank of Internet that pays 2.5%. Andy Micheletti, the bank's chief financial officer, says that the bank is lending money at an effective rate of 6.75%, so it can afford to pay savers 2.5% and still make a profit. In addition, as an Internet-only bank, it does not have the expense of maintaining bank branches.

Yields on money-market funds remain low because they mirror the current low yields of Treasury bills and other short-term securities that make up their portfolios. Plus, investors' confidence in the safety of money-market funds was shaken last fall when Reserve Primary Fund "broke the buck" -- that is, its net asset value (NAV) fell below $1.

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The Securities and Exchange Commission has proposed regulations that would establish new liquidity requirements, bolster the credit quality of the funds' portfolios and require more-frequent disclosure of fund holdings. The new rules are unlikely, however, to include a switch to a floating NAV, which would mean that individual investors could lose money. Pete Crane, editor of Crane Data, says that investors won't notice any changes when the new rules are enacted.

Senior Reporter, Kiplinger's Personal Finance