Wednesday, December 14, 2011

How Safe Is Your Cash?

Question: A few years ago, I remember hearing that money market funds were covered by FDIC protection just like certificates of deposit and savings accounts. Are money market funds still FDIC-insured?

Answer: The short answer is no, money market fundholders don't have the same guarantees that holders of CDs, money market deposit accounts, and checking and savings accounts have.

But your memory serves you well because money market fund investors were accorded extra protections when the financial crisis evolved in 2008. At that time, a large money market mutual fund, the Reserve Primary Fund, "broke the buck," meaning its holdings dropped in price, which in turn caused the fund's net asset value to drop lower than $1. That event created panic selling among some holders of money market funds, prompting the Treasury Department to start a new program, similar to FDIC insurance, for money market funds.

Under the Treasury's program, investors who owned money market funds before Sept. 19, 2008 (the date that the Treasury introduced the program) were guaranteed to be "made whole" if their funds' net asset values dropped below $1. (This FINRA posting provides details on the program.) The Treasury's program expired a year later, however, meaning that the Treasury, FDIC, or any other entity do not insure the assets in money market mutual funds. Thus, if the peace of mind of a guarantee is important to you, you'll need to stick with CDs, money market deposit accounts (not to be confused with money market mutual funds), and checking and savings accounts. Just be sure to mind the limits on FDIC insurability.

Not All Is Lost
That said, the fact that money market funds aren't insured doesn't mean you should automatically eschew them. Yields on nearly all cashlike vehicles are low across the board right now, but at other points in time, money market mutual funds might provide better yields than you'd obtain with other cash products. In addition, money market funds also offer daily access to your money, which is not an option for CD holders. Finally, there's the convenience factor: If you frequently move money into your long-term investments from your cash accounts, holding a money market fund with your investment provider can make these transfers seamless.

It's also worth noting that, notwithstanding the high-profile case of the Reserve Primary Fund, money market funds have a good record of preserving investors' capital. Since the introduction of the first money market fund 40 years ago, there has been a very small handful of funds that have broken the buck; all the rest have maintained stable net asset values. And following the financial crisis, the Securities and Exchange Commission, which regulates money market funds, imposed more stringent standards on money funds, instituting new requirements for liquidity, credit quality, and maturity.

If you do opt for a money market fund for your cash holdings, take a common-sense approach to ensure that you don't get stuck with an outlier. As with all investments, be on high alert if a money market fund offers an appreciably higher yield than competing funds and does not have ultralow expenses; that can be a red flag that it's taking more risks than its peers are. (Morningstar doesn't provide data or analysis on money market funds, but you can find data about current yields and expense ratios on your financial providers' websites.)

It also makes sense to stick with money funds offered by very large providers with extensive operations outside of the money fund business. Thus, in a worst-case scenario in which a money market fund's NAV falls lower than $1, the provider could contribute the cash to make investors "whole." (Several financial providers quietly did so during the financial crisis; shareholders suffered no ill effects.) Finally, if you have a lot of cash on the sidelines, it's worthwhile to spread your positions among multiple providers for diversification purposes; you might also consider splitting your cash assets among accounts that offer FDIC protections as well as those that do not.

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