Here we discuss safety of money market funds and what could diminish it. This is important information and it goes against some common misconceptions.
How safe are money market funds?
Money market funds invest in securities that have maturities of up to 13 months. However, the weighted average maturity can’t exceed 60 days. What’s more, a fund can’t invest more than 5% of its assets into a single issuer, while the debt needs to be highly rated. The problem is that even highly rated debt (investment grade is BBB and higher) can be downgraded and potentially go into default.
Money market funds aim to maintain their Net Asset Value at $1, or as close to it as possible. The gains on investments are paid to shareholders as dividends. If the NAV of a money market fund goes below $1, then it’s said that the fund is “breaking the buck.” That’s when investors can lose money if they decide to redeem their money market shares.
The “buck” has been broken as recently as 2008. It happened during the financial crisis, especially with those funds that invested in Lehman Brothers debt. The 2008 financial crisis created fear among investors and many rushed to liquidate their money market holdings. Only the government rescue, which made guarantees to money market investors, prevented many funds from breaking the buck.
However, the new financial regulations pertaining to money market funds such as Dodd-Frank Act prohibit federal agencies (the Treasury Department and the Federal Reserve Bank) from bailing out the money market investments in the future.
On top of it, FDIC insurance doesn’t apply to some money market investments such as those held at a brokerage house. It means these investment vehicles are not insured as bank deposits, although many brokers will provide other insurance. Thus, before investing, it is advised that you read the fund’s prospectus to understand the risks, and see what your financial institution is offering for protection. Note, however, that money market deposits at a bank can actually be FDIC-insured.
In summary, don't assume that your money is insured. Always check it with your financial institution whether it is a brokerage firm or a bank.
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