Is Your Money-Market Fund Safe? How to Find Out
The financial crisis sweeping Wall Street has even sparked worries about one of the safest investments around: money-market mutual funds.
The normally rock-solid reputation of money funds—which typically invest in short-term debt such as government and corporate bonds— took a major hit Tuesday when the value of Primary Fund RFIXX shares fell below the $1 benchmark for the funds.
The phenomenon, generally known as "breaking the buck," means that holders in that fund actually lose money.
Though most money funds are insured against such losses, not all of them are. So if you're worried about your so-called safe investment, take a poker player's strategy: Know what you're holding and what you're playing against.
Troubles at Primary Fund, which sustained some $40 billion in withdrawals since Friday, sent some investors scurrying for cover that their supposedly safe investments were in peril.
"You've got some people that are freaked out now," says Dennis J. Barba, managing partner of the Oxford Group of Raymond James Associates in Cleveland. "It's a crisis in confidence that could lead to worse things happening."
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Here's how to protect yourself: Check the prospectus to see where the funds are invested, and "reading the small print" in the agreements to find whether they're insured against losses, says Amber Dakar, personal finance expert at Money and Markets investment newsletter.
"If the fine print says an investment in this fund is not insured or guaranteed by the FDIC or another agency, that is a red flag," she says. "If they're risk-adverse, maybe that fund is not for them."
The Federal Deposit Insurance Corp. backs up $100,000 cash in its member banks and $250,000 in retirement accounts. The Securities Investor Protection Corp protects investments up to $500,000 in net equity balance and $100,000 in cash in the event that a broker-dealer defaults.
But not all money funds are necessarily covered, and Dakar says it's incumbent on investors to find out their exposure. Investors may want to consider withdrawing funds that are placed in the riskier areas of the market. Money markets consist of interest-bearing securities normally with short-term maturities, invested in government debt and asset-backed commercial notes among other places.
"Unfortunately for those who are invested in reserved primary funds where the investment is not insured or guaranteed by the FDIC or any other government agency, it's possible for these individuals to lose the money they invested in these funds," she says. "It's in the investor's best interest to know the brokerage in which they're placing their liquid investments."
"You need to know what you own and why you own it," adds Barba, who cautions against investors shopping for yields that may be marginally higher than safer funds like US Treasurys but also come with more risk. "Do some due diligence on what you own."
Time to Panic?
For now, the incident at Primary Fund is being treated as a one-off event that hopefully won't be replicated at other managers across the country, though many investors flocked to gold as a hedge against more troubleeven as money managers sought to assuage their clients' fears.
That situation occurred largely after Primary's $785 million holding in Lehman Brothers was reduced to zero because of the investment banker's bankruptcy filing. The fund had to put a freeze on investor redemptions after its assets went from $62.6 billion on Friday to $23 billion Tuesday. It is believed to be the first time where investors will lose money in a money market fund and only the second time a money market fund's net asset value fell below $1 per share.
Yet there appeared to be little sense of panic among investors that Primary Fund's problems could be the first of many money market difficulties.
"With all the stuff going on this year, to have that be the first fund to go below a dollar is probably testament to how sound the market is," Barba says. "You would have expected more of them to go lower."
At the same time, this is probably not the moment for risky plays in any part of the market, even cash.
"They're looking for return," Dakar says. "That's always good to look for. But in today's environment, it's good to err on the side of safety."