Think Your Money's Safe?

It's the most painful lesson of the credit crisis so far: Some so-called safe investments have turned out to be anything but. Boring, everyday financial products like money-market funds and bank accounts were supposed to be rock solid-and in exchange for that safety, investors accepted low returns. But when IndyMac Bank failed, almost 9,000 depositors faced losses, and when the Reserve Primary Fund faltered, hundreds of thousands of investors found their accounts frozen. What's more, bond funds, traditionally a lower-risk choice for people who can't afford big losses, have posted dismal returns. "There are no more safe havens," says Michele Gambera, chief economist at Ibbotson Associates. "Every investment has a risk."

If stocks are making you nauseous, bonds will settle your stomach. Or so goes the investing gospel. Bonds usually rally when stocks falter; they're also supposed to keep the ups and downs to a minimum. So with the market in free fall, no wonder skittish investors looked to bond funds. Surely, they would provide a cushion.

Not this time-at least not for most bond funds. Investors who raced to bonds for safety quickly learned that not all bond funds are created equal. Most logged losses right along with the stock market, and some of the most popular downright tanked, losing more than 25 percent. Indeed, some bond investors are filing arbitration claims against money managers; others are still in shock. "I never told clients to expect this kind of negative return on a bond portfolio," says Tom Ruggie, a financial adviser in Florida. "I never thought it'd be an issue."

For funds that hold Treasury bonds and other ultrasafe government securities, it wasn't an issue. They've managed to post modest gains this year. But most bond funds also hold corporate debt and issues of varying quality. With their higher yields, riskier bonds are lucrative in good times-and horrible in bad markets. For investors who weren't aware of the difference, says Lawrence Jones, a Morningstar analyst who covers bond funds, "this has been catastrophic." Because while stock funds tend to recover from big losses with big gains, bond funds typically post more modest returns. It could take years for some bond funds to get back to where they started.

Still, for long-term investments, experts say a broader bond fund is better than an ultraconservative one. A diversified portfolio should limit the damage from any bond blowups. And even in this market, most bond funds haven't lost nearly as much as stock funds have: The average intermediate-term bond fund is down about 7 percent this year. But if investors didn't know to scrutinize a bond fund's portfolio as carefully as they would a stock fund, they know now. And as short-term havens, bond funds are damaged goods. "If you need $60,000 in cash next year, a bond fund won't do it," says Ruggie.

Andrew Wall is the first to admit he's no financial wizard. He didn't have to be, though, to log on to his 401(k) plan and see that every investment option he had was in the red. Except for one: His stable value fund was up about 5 percent for the year. "It was a fairly simple deduction," says Wall, 39, who runs the human-resources department at a media company in Iowa. He read the prospectus, then moved his entire balance into the fund. "If I could get my money into something stable, what did I have to lose?"

Well, there's no free lunch. For eight out of 10 retirement plans, stable value funds are the lowest-risk option available. Bond portfolios wrapped with insurance guarantees, they promise to protect principal and smooth the returns over time. In the past 15 years, they've performed almost as well as bond funds, with 10 percent of the volatility. But that doesn't mean they're bulletproof. If the underlying bond portfolio loses money, the insurance company is on the hook for the difference. So the success of a stable value fund hinges on the insurance company's ability to meet its guarantees, says Pamela Hess, director of retirement research for Hewitt Associates. These days, with some big insurers on shaky ground and bond portfolios down 10 percent or more, that's a real risk.

Still, most experts say the chances of catastrophe are small-no stable value fund has lost money in recent history. The more likely problem is often overlooked by investors who don't read or understand the fine print (and who does?): Most stable value funds allow you to invest money only from a stock or bond fund. Moves from another "safe" option are prohibited. That means you can't take your money from, say, a money-market fund and move it into a stable value fund without first spending 90 days in the markets. And that, as we've seen, is anything but stable.

When investors raced out of the tumbling stock market last fall, many had just one word for their broker: "Sell." They stashed the proceeds in money-market funds or let them sit in cash-management accounts-which, at most brokerage firms, amounts to the same thing. More than anything else, these investors wanted peace of mind. And unlike more-volatile bond funds, money funds were supposed to be so safe that they could compete with savings accounts for investors' money.

Now those same investors are finding it's not so simple. The most highly publicized problem, of course, was the September failure of the Reserve Primary Fund, only the second money-market fund ever to lose money, or "break the buck." The $51 billion fund ran into trouble with risky investments, and investors stand to lose 3 percent. To make matters worse, they found their assets frozen for months.

The government's program to shore up other money-market funds helped restore confidence: After withdrawing $120 billion from those funds in one week in September, investors returned most of that money in the following weeks. But there are still gaps. Money-market funds are covered only if they opted into the government insurance program, and the program covers assets in the funds only as of Sept. 19. Most unsettling of all, it comes with an expiration date, now set at April 30, unless it's extended by the Treasury Department. Amy Krakow, a Manhattan business owner concerned about safeguarding her retirement accounts, was surprised to hear that the government guarantee is temporary. "I had absolutely no idea," she says.

Unfortunately, there's no easy way for investors to judge money funds' relative safety. Experts say it's best to avoid the top-yielding funds in favor of more-average performers. In that ultracompetitive market, earning even a little more can involve outsize risk. Funds from bigger mutual fund companies may offer some protection too, because they've traditionally put up assets to back their money funds-and by extension, their reputations. Some brokerage customers have a more secure alternative. Firms like Merrill Lynch, Fidelity and Charles Schwab allow customers to move their money to accounts insured by the Federal Deposit Insurance Corp.

Not only are the doors open at local IndyMac branches, but the scene inside is surprisingly ordered. Now that the federal government is running the failed California bank, there's no line around the block, only tellers at the windows and fully functioning ATMs. The calm is deceptive: The bank's recent collapse was a big hassle even for those whose accounts were fully insured; what's worse, the 8,799 customers with uninsured deposits could lose as much as $270 million.

In the wake of that disaster, the federal government ramped up protection: Congress raised the limits on deposit insurance from $100,000 to $250,000, and the FDIC now guarantees all the money in small-business checking accounts. But the extended protections expire at the end of 2009. So that three-year, $250,000 CD? Starting on Jan. 1, 2010, less than half of it is protected.

The government is hoping that by then banks will be stable again and no one will need the extended insurance. But when even giants like Citibank look fragile, financial advisers say it's best to act like the $100,000 limits are still in place. For larger deposits, many banks participate in the Certificate of Deposit Account Registry Service (CDARS), which takes the burden off customers by farming money out to different banks. Pay attention to the limits, says Bankrate analyst Greg McBride, and there really is no risk. "There's just no need to have exposure to a bank failure."