By manybanking.com Staff
In the past, money market funds have been considered extremely safe places to park cash. However, due to the current economic crisis, that assumption has been called into question. Most notably, the Reserve Primary Fund “broke the buck” as a result of the Lehman Brothers’ bankruptcy.
The Primary Fund losses, to the tune of 3 cents per share, triggered a run on that fund. To prevent future instances of such, the Treasury implemented a guarantee program that covers cash invested in funds prior to Sept. 19th, 2008. The program was recently extended through Sept. 18th, 2009.
While there has always been a known risk to investing in money market funds, that risk was rarely heeded because losses were incredibly rare. Given the new reality of these so-called safe investments, there are additional factors investors should consider when shopping for a money market fund.
- Look for funds from larger money management companies. If a fund does get into trouble like the Reserve Primary Fund, a larger management company is more likely to have the wherewithal to make investors whole. Companies like Fidelity (Stock Quote: FNF), for example, have a greater capability to protect customers from losses if their money fund breaks the buck.
- Diversify money fund holdings as you would any other type of investment. Spread money in money market funds among multiple providers to hedge against difficulties or the risk of one failing.
- Don’t let yield be the sole determining factor in your decision. In general, money market funds do not offer high yields, but some yields are higher than others. Money funds invested in Treasury bills, for instance, produce very low yields around 0.1%. Other types of money funds can offer higher yields, but they also expose investors to greater risk. Prime funds that are invested in corporate debt, for example, have a higher risk of default as demonstrated by the Reserve Primary Fund. Be sure to research the underlying investments of a money market fund to judge the risk of investment.
- Pay attention to expenses and fees. Like all mutual funds, money market funds incur management expenses that are passed on to the customer. If a fund has high expenses, those costs can end up canceling out the already low interest earnings investors have grown accustom to. By the same turn, management companies are seeing their profits fall or vanish because of low interest earnings. As a result, some are raising fees to recover a portion of that loss. Compare expenses and fees between funds to maximize your earnings.
Overall, people look to a money market fund as a safe place to store cash when they don’t want to invest in the market. However, given the increased risk in these funds, consumers might consider parking their money in an FDIC-insured bank account instead. Though some FDIC-insured accounts have similar yields to money market funds, the benefit is the added protection of insurance coverage if the bank happens to fail.
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