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Is Your Money Fund Safe?

In healthier economic times, money funds were seen as a sure thing. But times are changing.

by: Liz Weston, from: AARP The Magazine, November 2011 issue

Dear Liz: We have a lot of cash sitting in a money market fund, which I always thought was safe. Lately, though, I've been hearing that debt problems around the world could jeopardize money funds. Are the funds safe or not?

fan blowing a stack of money that is tied down with twine

The shifting winds of the markets have affected money funds. — Photo by Adam Voorhes

They're pretty safe, just not perfectly safe.

Unlike bank accounts, money market funds aren't insured by the federal government. Money funds almost always are priced at $1 a share, but during the 2008 financial crisis a fund known as the Reserve Primary Fund dropped to 97 cents a share. (It had lost money on securities in the failed Lehman Brothers investment bank.) A handful of other funds would also have dropped a few pennies per share, but the fund companies voluntarily made up the losses, and Uncle Sam stepped in with a temporary guarantee to keep panicky investors from pulling out.

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Money funds are mutual funds. Money market accounts come from banks. Key: Banks have FDIC insurance.
Today, if a fund yields much more than 0.2 percent, it isn't a true money fund. It's taking risks the manager isn't telling you about.

Since then, the Securities and Exchange Commission has further limited the risks money funds can take, requiring them, among other things, to put a greater share of their portfolios in securities that can be quickly converted to cash. Fund managers say their exposure to wobbly foreign debt is minimal, and besides, Uncle Sam would step in again if things got too bad. Probably.

Next: Why funds fall short. >>