Money Market Funds Enter a World of Risk By TARA SIEGEL BERNARD

September 18, 2008
Your Money
Money Market Funds Enter a World of Risk By TARA SIEGEL BERNARD

Money market funds have been among the few places that investors could put their cash and sleep peacefully.

At the moment, that is not necessarily true.

On Tuesday, the Reserve Primary Fund, a giant money market fund whose parent helped invent that investment, said its customers would lose money. Instead of each share being worth a dollar for every dollar invested, it said its customers’ shares were worth only 97 cents. In Wall Street parlance, it “broke the buck,” a rare occurrence.

So far, it appears that no other money market funds have fallen below a dollar a share. And other money market managers have hastened to reassure investors that their money is safe. But the Primary Fund’s announcement did raise this question: What, in today’s world, is truly safe?

After all, the Primary Fund’s troubles did not occur in isolation. They followed the disappearance of both Lehman Brothers and Merrill Lynch, not to mention the government bailouts of the mortgage finance giants Fannie Mae and Freddie Mac and the insurance company American International Group. And if you haven’t already forgotten, there was the failure of the California thrift IndyMac in July.

And that’s why, in this market, financial advisers agreed on Wednesday, consumers need to become their own chief investment officers, even when it comes to something as simple as finding a place to put their cash.

“One by one, all of my safe havens aren’t so safe anymore, and that’s a bad thing,” said Matthew Tuttle, a certified financial planner and president of Tuttle Wealth Management in Stamford, Conn.

“It used to be O.K. to have money in a CD, but now you have to worry, ‘Is my bank going to go under?’ ” he added. “You used to be able to buy a guaranteed annuity from an insurance company, but now you have to worry, ‘Is my insurance company going to go under?’ Or, you can have auction-rate preferred securities, but now there is no market.”

Before you pull your cash out of your money market fund, you need to understand what you own. There is a big difference between money market mutual funds and the money market deposit accounts at a bank (and banks sometimes sell both).

Money market funds are essentially mutual funds that invest in securities that, until this week, were deemed relatively low risk. Those include government securities, certificates of deposit, asset-backed commercial paper and other highly liquid securities.

The Primary Fund got in trouble because some of its investments were in Lehman Brothers’ debt. To stop what is in essence a run on the fund, the Primary Fund has stopped all redemptions for up to seven days.

A money market deposit account, on the other hand, is entirely different. It is an interest-bearing bank account that is insured — up to $100,000 per account and up to $250,000 for some retirement accounts — by the Federal Deposit Insurance Corporation. Joint accounts are insured for $100,000 per account holder.

If you had been putting your money into a money market account because you wanted to avoid all risk, then you should consider the money market deposit accounts and other accounts insured by the F.D.I.C., like certificates of deposit and regular checking and savings accounts.

There are also Treasuries. But because so many investors were rushing into them on Wednesday, the yields have been driven down. “There is no yield,” said Saxon Birdsong, chief investment officer of Baltimore-Washington Financial Advisors. “It’s just a safety play.”

If you decide to invest — or stay — in a money market fund, there are several things you should keep in mind.

When it comes to money market funds, bigger may be better, several financial advisers said. Many investors use the funds that happen to be with the brokerage firm they are doing business with because it’s convenient to sweep money between accounts. But you should make sure your money market account is with a large, diversified money management company that would have the resources to make you whole, even if its funds ran into trouble.

Mr. Tuttle said companies like Fidelity and Vanguard fit into this category.

“I would be less comfortable with a smaller money management fund that didn’t have a lot of assets and wasn’t making a lot of money,” he said. “From my standpoint, I have a very high comfort level that if a Fidelity money market fund had toxic whatever, they would step up with the money from somewhere else to keep the buck.”

Once you decide on a provider, read the prospectus carefully. If you don’t understand the investments, call the company and ask for more details.

“I would encourage investors to not stop asking questions until they have complete comfort and peace about what they own,” said Karin Maloney Stifler, a certified financial planner with True Wealth Advisors in Hudson, Ohio.

And if you are still nervous, ask your current mutual fund company or brokerage if it has a Treasury or government money market fund that invests only in Treasury securities, said Greg McBride, senior financial analyst at Bankrate.com, a personal finance Web site.

“You will have to settle for a lower yield,” he said, “but it takes risk off the table.”

Indeed, this is one of those times when you shouldn’t necessarily choose a fund because it has a high yield. That higher yield could indicate that the fund is investing in riskier securities.

“This is a painful but poignant reminder that anything that is paying you a higher yield, you have to assume is carrying a higher risk,” said Peter Crane, president of Crane Data, which tracks money market mutual funds.

Finally, investors should diversify cash holdings, just as they would with a stock and bond portfolio.

“If you have money market mutual funds with multiple providers, you are hedging against the risk that any one of them will encounter problems that they can’t survive,” Ms. Stifler said.

But if you don’t have a strong stomach for the slightest risk, stick with investments that are F.D.I.C. insured, even if you need to sacrifice a little yield.

After all, “this is a portion of your portfolio that should help you sleep at night, not keep you awake,” Mr. McBride said.

The Investment Company Institute, the mutual fund industry’s trade group, compiled a list of statements late Wednesday from money-market mutual fund managers that assured investors their funds were safe. Here are the links to the fund company’s statements:

Blackrock (pdf)
Columbia Management (pdf)
Evergreen Investments
Federated Investors (pdf)
Franklin Templeton
Invesco (pdf)
Legg Mason(pdf)
MFS (pdf)
Oppenheimer Funds
Pimco
Schwab (pdf)
State Street
T. Rowe Price
Vanguard