Fund Watch
Is Your Money-Market Fund Still Safe?
Most likely yes. But these steps will lessen the likelihood that your money will be at risk.
By Bob Frick, Senior Editor, Kiplinger's Personal Finance
September 17, 2008
Oh, great. Not only is the stock market melting down, but now I have reason to worry about my supposedly safe money-market fund? Millions of Americans may be thinking that today as news spreads that the Reserve Primary fund (symbol RFIXX) "broke the buck." That's industry jargon for a money fund, which is designed to maintain a stable value of $1 per share, seeing its share price drop below that level. At last word, Reserve Primary's shares were worth just 97 cents.
Reserve Primary got caught holding $785 million of Lehman Brothers debt securities. When Lehman declared bankruptcy, Reserve valued the securities at zero, which sparked a run on the fund -- although the bad Lehman paper accounted for just 3% of the fund's assets. On September 15 and 16, customers, mostly institutional investors who keep close tabs on their money, withdrew $27.3 billion from the fund, leaving it with $62.6 billion. The Reserve, a New York City money-management firm that runs the fund and boasts of having created the first money fund, in 1970, didn't have the reserves or the borrowing capacity to cover the loss from the Lehman securities.
Peter Crane, of Crane Data, says individual investors accounted for about $10 billion of the fund's assets. He believes that this is the first time individuals have ever lost money in a money-market fund.
Yes, we live in interesting times. Notwithstanding the Reserve fund's foul-up, however, your money-market fund is almost certainly safe. And if you're still not reassured, you can take some simple steps to lessen the likelihood that your sleep-tight money will be at risk. But first, here are some facts to put the situation in perspective:
Investments in money funds go bad more often than you think. Since August of last year, 20 fund advisers have had to support the dollar price, according to Crane Data.
It's been 14 years since a money fund broke the buck. In that case, shares of Denver-based Community Bankers U.S. Government Money Market fund dropped below $1, and the fund was forced to liquidate; investors received 96 cents on the dollar.
The Lehman collapse, and problems at other troubled financial companies whose short-term debt is held by some money funds, is a tiny fraction of the $3.6-trillion industry.
This is not to minimize the financial sector's problems and the panic investors are feeling. Says Kathleen Gaffney, co-manager of Loomis Sayles Bond: "I think people are going to be nervous about holding money-market funds. These are unprecedented times."
One way to calm your nerves is to understand what's in your money-market fund. (For a more detailed explanation, see Are Money-Market Funds as Good as Cash.) Money funds hold only short-term debt. By definition, no money fund can have an average maturity -- the time when debt comes due -- of more than 90 days, and no holding can have a maturity greater than 13 months. The average maturity in all taxable money funds is about 45 days.
Money funds come in several varieties. Among taxable funds (there also are money funds that invest in tax-free municipal debt), the safest hold only U.S. Treasury securities. These are bulletproof bills and notes backed by the full faith and credit of the U.S. government. More common are government-only funds, which own Treasuries but also hold government-backed securities from other issuers, including Fannie Mae and Freddie Mac. That's one reason the government wouldn't let the mortgage giants fail.
The most common money funds, commonly called "prime" funds, also invest in a variety of debt that isn't backed by the government. These short-term IOUs include commercial paper, certificates of deposit and repurchase agreements, or repos-basically overnight loans to banks or securities dealers.
You pay a price for safety. The ultra-safe, Treasury-only money funds yield the least, and in these troubled times, their yields are truly small. The seven-day yield for the average Treasury-only MMF is now about 1.15%, according to Connie Bugbee, managing editor at iMoneyNet. This compares to a yield of 1.84% for "prime" money funds.
So if you're nervous about the safety of your money fund, what steps should you take? If your fund is with one of the biggest financial-services companies, such as Fidelity, T. Rowe Price or Vanguard, just relax. They have the wherewithal to support their money funds should some of their investments sour. And all were quick to assure investors on September 17 that their funds were well diversified and in no danger of losing a penny.
If you want to be certain of avoiding a Lehman-like debacle shaving some cents off your MMF, you can trade in your prime fund for a government-only or Treasury fund. Bugbee says many investors made such a trek last fall as the subprime-mortgage mess was coming to light. Getting out of MMFs entirely and stashing your money in a government- insured bank account is only for the truly paranoid.
"I myself," says Bugbee, "would stay put."
Reader Comments (5)
Posted by: Andy at 09/19/2008 11:06:36 AM
I made the move today because I wanted to fully protect my cash funds I decided to move them from my Vanguard prime money market account to my online ING Direct savings account (www.savingtoinvest.com/2008/09/moving-my-vanguard-money-market-funds.html). This is not a reflection on Vanguard, because it is the best fund manager in the industry, it is more a risk management move on my part due to all the financial market and institutional turmoil.
Posted by: Ellen at 09/20/2008 10:29:25 AM
We had a good deal of money in Vanguard's prime money market fund. On Friday, we (put) it into a ladder of CD's. Since we are near retirement, we cannot afford to take unnecessary risks.
Posted by: Dan - NYC at 09/25/2008 04:31:40 PM
I am invested with Vanguard's NY tax exempt MM. I stay and will remain fully invested there.
Posted by: Brad at 09/26/2008 11:57:08 PM
Vanguard's Prime MMF has over half of it's portfolio invested in US Treasuries and Federal-backed Agency Securities. If you don't need the money you have in a money market fund for a certain period of time then a CD ladder is not a bad idea, but as far as safety goes I really don't see anything to worry about with a fund with that much liquidity that is making prudent, conservative investment choices. Look at expense ratios. When a MMF has a bigger than average yield net of a sizeable expense ratio then it must be investing into higher risk, higher yield securities to pay the expense ratio AND have a higher than average yield. A fund is only as good as the underlying securities. People that chase the highest yields will find themselves in the riskiest MMF's...higher risk, higher reward. But the author is right...you can always go into a MMF that invests soley in Treasuries or Federal Agency Securities--after all, if the government defaults on it's debt, then what good will FDIC insurance do?
Posted by: susan at 09/27/2008 01:40:58 AM
I have a good deal of money in Vanguard MMF(prime fund). I check with Vanguard every few days for reassurance, but so far I am sticking-sorta. My account manager told me today that Vanguard opted not to participate in govt. insurance. Yikes!! These are scary times to be so confident. I am moving to government backed money( at least half), also takng a smaller amount to buy gold(Krugerrands) and taking a small amount in cash to stash under my mattress. I'm the guy in the fox hole wearing the Star of David, the Crucifix, a Buddha etc. around his neck. I want to be covered in all cases.