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?
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.
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. >>
Still, you don't want to invest expecting to be bailed out. And you're certainly not being compensated for the risk: Money funds are paying as little as 0.01 percent. (Not a misprint.) Many banks offer more, along with a federal guarantee. And that is perfectly safe.
Risk, No Reward
Used to be that money market funds offered higher yields than banks. That was your reward for taking a little extra risk and forgoing the bank's federal insurance. These days, though, there's no reward for the risk.
The assets money funds hold, such as Treasury bills, yield close to zero. Lots of banks beat that. With a little online digging, you can squeeze out half a percent or so in a CD or savings account insured by the FDIC (banks) or the CUNA (credit unions).
Liz Weston, author of The 10 Commandments of Money, blogs at Ask Liz Weston.