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Mutual Funds

Understand Money Funds' Risks

Shrink your chances of losing money by learning how to pick the best funds for you.

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Money-market funds have a reputation for being about the safest uninsured, non-Treasury investment around, and it's a well-earned reputation. Since they were created in 1972, no individual investor has lost a cent of principal in any of the hundreds of funds you now have to choose from. This safety record was built partly on restrictions that govern the funds and partly on the fund sponsors' determination to keep the public's faith in funds strong.

Securities laws dictate that the average maturity of a money fund's holdings may not exceed 90 days, and any individual debt instrument owned by a fund must mature within 13 months.

But a slim chance doesn't mean no chance.

  • Default risks: There is a chance that your money fund could be left holding suddenly worthless notes, especially if the borrower goes bankrupt. In the unlikely event that a money-market fund holds securities that go into default, it helps to have your money invested with a well-capitalized company, such as Dreyfus, Fidelity, T. Rowe Price or Strong.

  • Interest-rate risks: The chief worry is a sudden spike in interest rates. The longer the average maturity of the fund at the time of the spike, the greater the danger.

How to limit the risks

  • Check the prospectus carefully to see what kinds of debt the fund will buy.

  • If the fund invests in commercial paper, make sure it's limited to issues receiving the highest ratings (they will be labeled A-1 and P-1) from the major rating services, such as Standard & Poor's or Moody's Investors Service.

  • Call the fund and ask about its current policy, which may be more or less conservative than is permitted by the prospectus.

Standard & Poor's follows several hundred money-market funds and rates them for safety.

To eliminate default risk entirely, look for funds that invest only in federal government securities. Some of these invest in a variety of government-issued securities, such as Treasury bills, and government-sponsored debts of agencies such as the Federal Farm Credit Bank, and repurchase agreements backed by Treasury issues. Another type of government-only fund buys just Treasury bills-the ultimate in credit safety.

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To control interest-rate risk, look into the fund's policy on the average maturity of its portfolio. Most prospectuses allow money funds to extend maturities to the maximum 90 days. As a matter of policy, however, many funds keep average maturities at 40 to 60 days. You can also find current average maturities in tables of money-market fund yields, which are published weekly in many newspapers.