Is Your Money-Market Fund Safe?

Updated on Sept. 19, 2008.

Money-market funds are supposed to be a safe haven for risk-averse investors. But that premise was turned on its head this week after money-management firm The Reserve announced that its Primary Fund (RFIXX) shares dropped below the $1 level -- otherwise known as "breaking the buck." This means investors receive less than the principal they invested.

The Reserve shocked the market Wednesday when it announced it cut the net asset value (NAV) of its Primary Fund to 97 cents a share. The fund held $785 million in Lehman Brothers debt, and was hit with redemptions in the wake of Lehman's bankruptcy. The fund's assets declined by $27.3 billion to $35.3 billion, according to Crane Data, a money market and mutual fund information company. Money-market funds, a $3.6 trillion industry, have run into problems in the past because of troubled securities, but this is only the second time that one has allowed its net asset value to fall below $1.

Investors did not take the news well, yanking $89.2 billion from money-market funds on Wednesday alone, according to iMoneyNet.com, a provider of money-market mutual fund information. On Friday, the Treasury Department announced the establishment of a temporary guaranty program for the industry. The Treasury said the move, which includes setting aside $50 billion to protect investors from potential losses, "should enhance market confidence and alleviate investors' concerns about the ability for money market mutual funds to absorb a loss."

"The government is providing a backstop, if you will, saying 'we'll cover your losses,'" says Lee Baker, a certified financial planner and president of Apex Financial Services, in Tucker, Ga. "I think it was necessary evil, and hopefully it will be more than a large Band-aid."

For now, Reserve clients who haven't yet redeemed their shares in Primary Fund can do so, but they may have to wait for the cash. The company issued a statement Tuesday saying that proceeds from redemptions of the fund won't be given to investors for a period of up to seven days.

As money-fund woes add to already-rattled nerves, what -- if anything -- should consumers do to protect themselves?

Highly irregular

First, consumers should understand that what happened at The Reserve is an anomaly. The Reserve's fund was forced into this position because it had large holdings in Lehman Brothers, but not deep enough pockets to protect the troubled security, says Peter Crane, president and CEO of Crane Data.

In the past year, there have been 21 instances of an advisor or parent company stepping in to protect the securities held in a money-market fund, but this is the only case of a fund breaking the buck, Crane says. "Other institutions protected their Lehman holdings so investors wouldn't be exposed, and the Reserve didn't," he says.

Alternatives

That said, consumers concerned about credit risk inside their money-market funds should look for a one that doesn't have exposure to such risk, like a Treasury money-market fund, says Troy Von Haefen, a certified financial planner and owner of Von Haefen Financial Management in Nashville, Tenn. These funds only hold assets in Treasury securities, which are backed by the government and thus have no risk. "The Treasury money-market funds are more stable, but the yield is much lower," says Von Haefen. Right now, Treasury funds are offering yields of around 1.6%.

As an alternative, Von Haefen likes Charles Schwab's checking accounts, particularly if you're already a Schwab client. As of Wednesday, a high-yield checking account at Schwab had a 3.0% yield. "You accomplished your goal of safety, you have liquidity and now you have a higher yield," he says. A checking account is also FDIC insured.

Investors can check yields on banks’ money-market savings accounts on Bankrate.com, which lists top-yielding accounts offered by banks nationwide. "The high-yielding money-market deposit accounts and savings accounts are paying yields above 3.5%. They're completely FDIC-insured, and you don't give up access to the money. It's still liquid," says Greg McBride, senior financial analyst at Bankrate.com.

Going forward

Investors are generally advised to hold money-market funds at big brokerages or mutual fund companies like Vanguard or Fidelity because these firms have the resources to protect them from the kinds of losses experienced by the Reserve’s shareholders. "The bigger the organization is, the deeper the pockets, the more resources it has" in case a fund finds itself saddled with troubled securities, says Crane.  

The latest news will have many investors questioning the soundness of their money-market funds and the ability of the company to make them whole should the fund lose value. But the Treasury’s latest action certainly "takes the pressure off," says Don Phillips, managing director at Morningstar. "If you’re at a fund that you’re not so sure about, you have much less reason to be concerned."