For several years, I kept my emergency fund in the Vanguard Prime Money Market Fund (VMMXX).  For a while, this Vanguard money market fund was yielding over 5% while most high yield savings accounts were stuck in the 4.5% range (those were the days, huh?).  This made perfect since, because while online savings accounts are FDIC insured, money market mutual funds are not;  I interpreted the yield differential as being compensation for taking on slightly more risk.

All figures are accurate as of the date of publication:  2/8/2010.

And Then Came The Crash…

2008 was a bad year for pretty much everything, but money market funds were hit particularly hard.  A few of the larger ones even broke the buck, meaning they had to be subsidized by their sponsoring company to prevent investors from suffering losses.  That was the last straw for me.

To add insult to injury, money market fund yields are as low as I ever remember them being in my (admittedly short) investing experience.  The highest-yielding taxable Vanguard money market fund, VMMXX, is not yield a dismal 0.02%.  That’s not a typo:  0.02%!  Surprisingly, the Vanguard Tax-Exempt Money Market Fund (VMSXX) yields over three times as much as its taxable equivalent, or 0.09%.  Even investors in the very lowest tax bracket will come out ahead with the tax-exempt fund, and that’s practically unheard of.

It’s Not Worth The Risk

To be sure, Vanguard is a fine mutual fund family and no Vanguard money market fund has ever lost money.  Furthermore, the Prime Money Market Fund has been very attentive to risk throughout its history.  There is no reason to believe any Vanguard money market fund will ever lose money;  however, I’m sure most investors in those other funds felt the same way.  It’s just not worth the risk.

Now, I hold my emergency fund at ING Direct, which is yielding 1.2% as of this writing.  Not only that, but my account is 100% FDIC-insured to the fullest extent of the law.  Even if the money market funds regain their usual yield advantage going forward, I think I’ll stick with ING because

  1. ING Direct’s rates are consistently competitive.  My emergency fund isn’t huge, so chasing the very highest yields isn’t a priority.  ING usually isn’t the highest on the market, but they are also never the lowest.
  2. Money Market Funds aren’t as safe as I thought they were.  The risks can go undetected for years at a time until the fund implodes with no warning.  I’m willing to take on additional risk with my long-term investments, but not my emergency fund.
  3. I have better things to do than worry about an extra $200 per year in interest from my emergency fund.  It’s there for safety, not for earning maximum returns.

The Orange Savings Account. Earn high interest. Great rates, no fees, no minimums. Start saving in under 5 minutes.

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