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Is Your Money Market Fund Really Safe?© Sound Mind Investing | November 2008
Something happened on Sept. 16, 2008 that had never happened before: a large retail money market fund "broke the buck." Investors, confident that they would always enjoy a constant share price of $1, learned that each of their shares was now worth only 97 cents. That may not sound like much of a loss, but the unprecedented news sent additional shockwaves through a stunned financial community already reeling from the implosion of three huge investment banks, the failure of a major insurance company, and the federal takeover of mortgage giants Freddie Mac and Fannie Mae. Until that mid-September day, money market funds had long been regarded as one of the safest of the safe havens, an investment in which customers would never lose their principal. When that long-held presumption suddenly evaporated, investors began making massive redemptions from money funds, prompting the U.S. Treasury Department to step in with a temporary guarantee program that promised to protect "the shares of all money market fund investors [held] as of September 19, 2008." (Fund companies weren't required to participate in the guarantee program, but most signed up and paid a premium to the U.S. Treasury.) The Treasury action helped stem the tide of MMF outflows, but the incident left many investors wondering if money market funds can still be considered a "safe" investment. That's a legitimate concern. Here's our view: despite the scary turn of events in September, money market funds remain one of the safest investments out there. Yes, MMFs are mutual funds and not bank accounts (and therefore don't carry FDIC insurance), but they are hedged in by three specific safety-related boundaries:
In addition to regulatory restrictions, a harsh reality of the free market works to protect investors: breaking the buck is a public-relations disaster. No company wants to suffer the crisis of investor confidence that follows a money fund meltdown. Indeed, as Don Phillips of the investment research firm Morningstar Inc. put it: "If you break the buck on a money market fund, you're saying that you don't want to be in the money market business anymore." This is why mutual fund companies are willing, if necessary, to call forth large infusions of cash from other company operations to shore up their MMFs. (According to Crane Data, at least 20 fund companies have done so since August of 2007.) Companies find it more palatable to swallow a one-time loss than live with a perpetual stain on their reputation. Unfortunately for Reserve Primary, the MMF that broke the buck in September, there were no deep pockets to draw on, since the fund's relatively small parent company was an MMF-only shop that wasn't diversified into other types of investments. In contrast, companies such as Fidelity, Vanguard, and T. Rowe Price have large resources they can use to help their MMFs get through any rough spots. It is difficult to imagine (even in this time of multiple unforeseen financial "firsts") that companies built on investor confidence would allow their MMFs to break the buck if they have any resources elsewhere that could be used to support the expected $1 share price. So, if despite the new government guarantee program, you're still a little leery, stay with the largest fund organizations. If you have lingering concerns about the safety of MMFs, there is one more "safety feature" you can add: put your money in a U.S. Government-only money fund (current best rates on Government-only funds can be found in our Best Rates tables). These funds invest only in obligations (debt) of the United States government. They have a slightly lower yield than "regular" MMFs, but they carry the security that comes with being backed by the full faith and credit of Uncle Sam. At least for the time being, his credit is still good.
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