Is Your Money Market Fund Really Safe?
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."
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:
- Short-term holdings. Federal regulations allow MMFs to invest only in securities with maturities of less than 13 months. Further, the average maturity of all the holdings in the fund can be no longer than 90 days. These short maturities protect against default risk, while also assuring that interest-rate changes don't drastically affect the funds (MMF yields will tend to move in lockstep with market interest rates).
- Diversification. No money fund is allowed to invest more than 5% of its assets with a single issuer, unless that issuer is the federal government.
- Investment quality. Money funds are required to limit their investments to securities rated as "high quality" by nationally recognized statistical rating organizations. (In the buck-breaking episode, ratings agencies unfortunately had rated short-term debt issued by Lehman Brothers as being high-quality and therefore relatively safe. When Lehman Brothers filed for bankruptcy, the debt was worthless and any MMF holding it had to write its value down to zero.)
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. 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. 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 you're still a little leery, even if with the government’s new guarantee program, you may want to put your money 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. 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.
© Sound Mind Investing
Published since 1990, Sound Mind Investing is America's best-selling financial newsletter written from a biblical perspective. 
to get 
Originally published December 03, 2008.
