Savers choose money-market mutual funds when they want to keep their money safe. Money funds behave like bank accounts. When you put in a dollar, you expect to keep that dollar plus whatever interest it earns. Current average yield on taxable funds: 4.1 percent, compared with 2.5 percent on bank money-market accounts.
But money funds are not bank accounts, they’re investments. There’s a tiny risk that the value of each dollar invested might drop to 99 or 98 cents, or even less. The industry calls that “breaking the buck” and considers it a capital crime.
For a couple of weeks, Wall Street’s rumor mills have whispered that a money fund would break the buck. No names supplied. The whisperers guess it’s a small fund, or a fund used mainly by institutions.
Wall Street rumors more often are wrong than right. But in case this one’s true, savers need to be put on notice. Money funds are enormously safe but not perfectly so. To avoid risk, you have to pay attention to what you’ve got.
Money-market mutual funds sell for $1 a share. They invest your money in interest-paying instruments that mature in short periods of time, such as a day, a week, a month, six months. The instrument might be a CD, a Treasury security or a short-term IOU from a corporation. There’s minimal risk that the instrument will default in that brief a period.
When a fund loses market value, that loss is normally reflected only in the yield. Your shares are still worth $1 each but your daily interest rate declines.
A fund breaks the buck when the interest it earns on its investments isn’t enough to offset any loss in market value. While rare, that’s not unheard of. About two dozen funds, including some government-securities funds, would have broken the buck this year, if the companies that owned them hadn’t bailed them out.
Those funds had been buying derivatives-complex investments whose returns are derived from price changes in other markets. Many derivatives plunged in value when interest rates rose. The fund sponsors rescued their investors by putting cash into the funds and taking the bad securities out.
Over the years, the Securities and Exchange Commission has gradually tightened the rules for money-market funds, to keep them as safe as investors expect. At present, money funds are under orders to get rid of their risky derivatives.
SEC commissioner Richard Roberts says it’s probably inevitable that a money-market fund will break the buck some day. “Investors are apparently getting the message that all mutual funds, even money-market funds, are not guaranteed by federal deposit insurance,” he said.
But Norman Fosback, editor of the Income Fund Outlook, a newsletter on bond and money-market funds, says he’d be surprised if such a thing happened. “There’s tremendous pressure within the industry, extending to the SEC, to maintain the integrity of the track record,” he says. “I can even see other sponsors offering financial support, to maintain the price of a small fund.”
Bruce Bent, president of The Reserve Fund and inventor of money-market mutual funds, says he’d contribute to another fund to keep it from falling-and then try to get that fund out of the business. Even if the rumor is true, Bent says, “it can’t be a significant fund. Any serious player would have covered a loss.”
Bent runs conservative funds that don’t buy derivatives. To double-check on your own fund, he says, call and ask, “Do you have any derivative exposure?” The best answer is “No.”
Money funds remain an excellent place for savings, provided you choose them well. When safety is paramount, that means no derivatives. And it means picking funds by what they invest in rather than by the highest yield. Some funds have high yields because they are currently waiving part or all of the typical 0.5 percent management fee. If they’re charging full fees and still top the performance list, they may be taking undue risks.
Consider money-market funds that stay out of longer-term securities; the longer the term, the greater the price risk. The average maturity on money-fund portfolios today is 48 days. Some, however, run to more than 80 days.
Money-fund investors willing to take perhaps 0.1 or 0.2 percentage points less in yield should consider Treasury funds. Sanford Bragg, managing director at Standard & Poor’s, says they are “very clean,” with no high-risk investment gimmicks.
