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How Safe Are Money Market Funds?

Question: In the past few years of following the financial news and your program, I've come to see the Money Market fund as a stable place for short-term emergency fund money. Very limited risk of loss of principle, and the very few times it has happened, investors got out with almost all of their money anyway.

Talking with a coworker recently, she said that she had experienced a money market fund dropping in value (presumably some 25-30 years ago). Was she just one of the unlucky ones or is the mantra of "only one money market fund failing" a story limited to the last 25 years? Adrian

Answer: Money market mutual funds, despite their billing, are not risk free. These funds are on the safe side of the risk spectrum because they invest in Treasury bills, short-term U.S. government agency securities, commercial paper certificates of deposit, and other very short-term debts. The security in the fund comes from diversification and the quality of the short-term debt the fund invests in.

There's the rub. In order to attract more money, some mutual fund companies take on riskier short-term debts to boost yields. And then the industry gets roiled by the risk that a money market mutual fund will "break a buck" during a market squall like now. In other words, the promise of a money market mutual fund is that if you put a dollar into it you will at minimum get a dollar back at withdrawal. As far as I am aware, the value of no major money market mutual fund has fallen so much that withdrawals have been worth less than a buck. However, I am aware that in some cases the parent company has injected cash into the money market mutual fund to preserve its value.

That's why I like money market mutual funds attached to a major brandname financial institution with the money to shore up a fund and a reputation to protect if there is a risk that the fund will break-a-buck. I also prefer lower yielding money market mutual funds composed primarily of U.S. Treasury securities and U.S. agency debt. I just don't think the risk of a slightly higher yield is worth it.

01/08/08 by Chris Farrell

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Financial Information Over the Phone

Question: I got a personal call from my bank the other day: they lowered their interests rates and could give me a home equity loan for 7.5% ... as opposed to the 10% I have now on my line of credit with the same bank.

All they needed to know was what my home was worth, how much I had left to pay on it etc etc, a lot of questions I didn't feel like answering on the phone. But is this really a good deal (the rate can and will change, right?) and does it affect my credit report to apply for more credit? Otherwise I would be tempted. Thanks for your advice, Sabrina.

Answer: I don't answer any personal finance question that comes my way over the phone or on the Internet. Period. (This approach seems to annoy unsolicited calls from charities asking for money the most. Tough.) It's too risky in an era of identity theft to give away financial information away to strangers on the phone or the Web.

Still, it sounds like your bank may be offering you a good deal--or at least one worth investigating. I would walk over to a branch of your bank and ask to talk to a bank manager. If that's inconvenient, you should initiate the call and solicit the information you want yourself.

01/14/08 by Chris Farrell

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Monitoring Financial Institutions

Question: In tough times like these, how do I monitor the health of my insurance company and bank? Sure the bank is FDIC insured but getting money back from the government can't be easy or efficient, how do I protect myself? Thanks in advance, Tim

Answer: This is a timely question. Federal Reserve Board chairman Ben Bernanke recently testified before Congress that he expects some small banks to fail. A number of insurance companies have also reported losses from subprime mortgage investments.

As you mention, the key with banks is to make sure it is backstopped by the Federal Deposit Insurance Corporation. The FDIC website has a clear explanation of the insurance basics. The basic insurance amount is $100,000 per depositor per insured bank. However, certain retirement accounts like IRAs, are insured up to $250,000 per depositor per insured bank. Now, there are a variety of ways to increase that insurance limit depending on the type of account. But most people are well below that $100,000 and, if that's the case, the FDIC is good sleep insurance. By the way, the FDIC has a sound reputation for restoring access to your money after a bank failure. This is from their website:

It is the FDIC's goal to make deposit insurance payments within one business day of the failure of the insured institution. Typically, a bank that has failed will be closed on a Friday. The FDIC will then work the weekend to complete deposit insurance determinations for most deposits and be prepared on Monday to either transfer the insured portion of a deposit to another FDIC insured institution or provide deposit insurance payment checks.

Insurance companies are regulated by the states, and the track record of state regulation is uneven (to put it charitably). Even the information for concerned consumers isn't easy to find. For instance, if you head to the FDIC website you can get most if not all of your questions answered. Now try and do the same information at the National Association of Insurance Commissioners website, the umbrella organization for state insurance commissioners.

Anyway, property and casualty, life and health insurers are backed by various state "guaranty funds". Here is the money quote from the National Organization of Life & Health Insurance Guaranty Associations:

Insurance companies that experience severe financial difficulties are taken over by the insurance department of the state in which they are based. You should be notified by the insurance department if this occurs. Even if the company is placed under the control of the insurance department, claims will continue to be honored as long as premiums are paid or cash value exists. The claims will be covered by state guaranty associations, which will either pay them directly or transfer the policies to a financially stable insurance company.

When it comes to insurance companies you'll want an extra layer of financial comfort. I prefer blue chip companies with high credit ratings from Moodys and Standard & Poor's.

03/03/08 by Chris Farrell

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Flight to Safety

Question: My wife and I are very cautious with our money--we have only one loan (our mortgage), we pay off credit cards every month, and we have more than 6 months of living expenses saved... BUT it's in a financial firm's money market account. We also have IRAs and "deferred compensation" saved in mutual funds.

The recent near collapse of Bear Stearns echoed the bank runs of '29 and the collapse of markets. It's an uneasy time--world markets seem unstable, inflation in energy and food costs etc... Should we be worried about having money saved in non-FDIC backed instruments? Worried in Ann Arbor. Jim

Answer: It is an uneasy time, especially with the Bear Stearns meltdown and takeover. But you are in a good financial situation to ride out the storm.

The answer to your question involves shades of risk. Let's look at your money market mutual fund. Every once in awhile, during tumultuous financial periods like now, the mutual fund industry is roiled by fear that a fund will "break a buck." The promise of a money market mutual fund is that if you put a dollar into it, you will at minimum get a buck back at withdrawal. As far as I am aware, no major money market mutual fund has fallen so much that withdrawals have been worth less than a buck. However, I am aware that in some cases where the parent company has injected cash into the money market mutual fund to preserve its value.

What to do about this? I always recommend a two-fold strategy. First, investors should put their money market money into a brand-name financial institution with the resources to support a money market mutual fund if it becomes necessary. Second, I would put my money into the most conservative money market option offered by the financial institution. The fund's assets should be primarily in very high quality short-term securities, such as U.S. government short-term debt and U.S. government agency debt.

If you believe that even after these two safety screens, a money market mutual fund is too risky, I would put my money in one of two places (or both): Keep it at a bank in FDIC insured accounts, such as certificates of deposit, a savings account or a bank money market deposit account. Or buy default-free U.S. Treasury bills directly from the government. It's easy to do. Check it out at www.treasurydirect.gov.

03/17/08 by Chris Farrell

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Online Banking

Question: As much as anything is "safe" these days, is it safe to open online savings/CD accounts with such companies as "ING Direct"? Sarah, Lakeville, CT

Answer: Yes. For safety and soundness, the key is to make sure that any online bank is backed by the FDIC, and ING is insured by the FDIC.

03/18/08 by Chris Farrell

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Money Market Savings Accounts

Question: Chris -- You mentioned money market mutual funds a couple times on last week's show. Are money market mutual funds the same as money market savings accounts? Can you get them at banks, or just brokerages? Are they still as liquid (make deposits, withdrawals) as money market savings accounts? Thanks -- I appreciate all of your and Tess's advice. Brian, Auburn, AL

Answer: Money market mutual funds and money market savings accounts are similar in many respects, but there are critical differences between the two. A money market savings account at a bank typically pays a higher rate of interest than a regular savings account. The account usually has a higher minimum balance requirement and limitations on the number of withdrawals a month. A money market savings is insured up to $100,000 by the Federal Deposit Insurance Corporation (FDIC). In other words, if the bank goes belly up, your money is safe (assuming you're under the insurance limit).

The same isn't true with a money market mutual fund. There is no FDIC insurance backstopping the account. In return, you'll get a slightly higher interest rate with the money market mutual fund compared to the money market savings account. Still, money market mutual funds are among the safest investment options available to individual investors. There are two simple ways to reduce risk with a money market mutual fund. First, invest with a brand-name financial institution with the resources to backstop a money market fund if it gets into financial trouble. Second, choose the most conservative fund option. It's the one that is comprised of mostly short-term U.S. Treasury securities and federal agency debt. There's no reason to chase higher yields by taking greater risks with this money. You want your principal safe and earn a decent interest rate.

04/23/08 by Chris Farrell

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Are Credit Unions Insured?

Question: With uncertainties concerning the financial soundness of some banks there has been reassuring mention in news stories of FDIC protections. I have yet to hear mention of similar reassurance to members of credit unions that belong to the National Credit Union Association. Is it in fact known that National Credit Union Share Insurance is on a par with FDIC and that invested funds are equally safe?... Roy, South Burlington, VT.

Answer: The short answer is yes. The outline of the insurance coverage is the same as FDIC, with a standard $100,000 protection that jumps to $250,000 for certain retirement accounts, such as IRAs.

You can get more information at the National Credit Union website at www.ncua.gov.

Here are highlights from their discussion of deposit insurance:

The shares in your credit union are insured by the National Credit Union Share Insurance Fund (NCUSIF), an arm of NCUA. Established by Congress in 1970 to insure member share accounts at federally insured credit unions, the NCUSIF is managed by NCUA under the direction of the three-person NCUA Board. Your share insurance is similar to the deposit insurance protection offered by the Federal Deposit Insurance Corporation (FDIC)...

Credit unions that are insured by the NCUSIF must display in their offices the official NCUA insurance sign which appears on the cover of this brochure. All federal credit unions must be insured by NCUA...

Not one penny of insured savings has ever been lost by a member of a federally insured credit union. The federal insurance fund has several programs to help insured credit unions which may be experiencing problems. Liquidations or failures are a last resort. If a federally insured credit union does fail, however, the NCUSIF will make any necessary payouts to the credit union's members. These payouts are usually done within 3 days from the time the credit union closes its doors.....

07/18/08 by Chris Farrell

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