Click here to listen to Eugene Groysman discussing what to do with money market funds

The Federal Reserve Bank of Boston revealed this week that between 2007 and 2011 at least 21 out of 341 money market funds reviewed would have “broken the buck” without support from their sponsor firms. As interest rates have fallen to levels that don’t even cover a money market fund’s operating costs, fund sponsors have subsidized their money market funds just enough to prevent them from breaking the buck, and no more. This is why so many money market funds have paid no interest since the beginning of the year, and one of two reasons its time to start selling money market funds.

At some point, it won’t make sense for fund sponsors to keep subsidizing these funds. When the Fed speaks of keeping rates low through 2014, they are telling money market fund sponsors that they will have to continue to subsidize their funds for at least 2 more years. And, when the Fed talks of further monetary stimulus, they are telling fund sponsors that the subsidies may have to be bigger. When fund sponsors have had enough, you’ll see money market funds closing down entirely. Both JP Morgan (JPM) and Goldman Sachs (GS) have already taken a first step to limit their subsidies by closing their European money market funds to new investors.

The second reason it’s time to start selling money market funds is that investors who are ahead of the curve are already finding better places to put their cash. This is why total assets in money market funds have shrunk to $2.5 trillion from $3.6 trillion 3 years ago. Investors who wait until the bitter end will find themselves competing for decent high income investments at the same time investors with $2.5 trillion will be looking for exactly the same thing.

Don’t wait until a fund closure forces you to take action.

If you have taken money out of the market and have it parked in a money market fund, think about putting a portion of your money market fund holdings into stocks like American Capital Agency Corp. (AGNC) to improve your yield.

AGNC invests in residential mortgage pass-through securities and collateralized mortgage obligations, for which the principal and interest payments are guaranteed by a U.S. Government agency or U.S. Government-sponsored entity. Its current yield is 14.3% or $5/share, but its risk (as measured by beta) when compared to the S&P 500 is .23. What that means is that AGNC’s volatility is about 77% less than the S&P. This means that if over the next year the S&P falls by 20%, AGNC would be expected to fall only by about 4%. However, after including the dividend yield of 14%, the investor will be ahead of the market by 10% and way ahead of a money market fund. Of course it would be even better to buy a portfolio of stocks like AGNC to get a little diversification. Click here for more information about such a portfolio.

If the primary reason you are in a money market fund is because you want income with little risk. Then by incorporating an 80/20 mix of money market funds and a portfolio of similar investments will increase your yield, while taking on only a marginal amount of market exposure. Putting 20% of your money market holdings in such a portfolio would increase your market exposure by 4.6% and increase your yield from .01% to 2.87% giving you a fighting chance to at least keep up with inflation.

If you are using a money market fund to park funds while you wait for the market to improve then putting 50-60% of the funds into a portfolio made up of similar investments as AGNC would; one, decrease your overall market risk, while at the same time give you a portfolio with a double-digit yield, so even if the market stays relatively flat, you would still have a decent return on your investments that compares well with the long-run return on the S&P 500.

Eugene Groysman who is the Marketocracy Master wrote this article. Click here to view his track record.

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Disclosure: I am the portfolio manager for mutual and hedge funds advised by Marketocracy Capital Management. an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.