Marketplace

Emergency stash

Question: I'm newly married and trying to put together a plan for budgeting and saving for our future. The book I've been reading suggests emergency savings of at least 3 months take-home pay, in addition to reserve savings for planned expenses. Additionally, it recommends keeping this money in a money market fund, or index fund with check-cashing privileges. In the past you've recommended index funds over other sorts of mutual funds. Can you talk more about this, and suggest some places to look? I will be making fairly small deposits, at least at first. Jeremiah, San Francisco

Answer: The advice to put the cash in a money market mutual fund is conventional and non-controversial. To use the Wall Street jargon, it's a very "liquid" investment, meaning you can write a check off your money market fund when you need funds in a pinch.

What I don't get is the index fund advice. When I talk about index funds, it's usually a broad-based domestic equity index fund, an international equity index fund, or a bond index fund. In each case, fees are razor thin and your investment will match the performance of the underlying index. However, these are riskier investments--you don't want your emergency savings tied to the movements of the stock or bond market. I think it's a great idea to put money into index funds in a taxable account, but I would reserve it for long-term savings, such as a child's college education.

12/27/07 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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Money market mutual funds

Question: If the government is now going to insure money market funds, will the return go down as the risk does? Carolyn, Tallahassee, FL

Answer: Yes, the return should go down. It's an axiom of modern finance theory that the only way to create the potential for earnings a higher rate of return is by taking on greater risk. Money market mutual funds, which weren't covered by the FDIC, paid investors more than comparable FDIC insured deposits.

Now, the federal government has created the equivalent of the FMMMFIC--the Federal Money Market Mutual Fund Insurance Corporation. Of course, that really means the American taxpayer is backstopping the $3.5 trillion in money market mutual funds for the next year. (It also means that everyone--like me--who accepted a lower yield on their money market fund in return for parking emergency money in the most conservative option paid an unnecessary interest rate penalty. Those that reached for yield just got bailed out.)

The federal guarantee that money market mutual funds won't "break-a-buck" is for a year. But there is no way to put this financial genie back in the Wall Street bottle. Everyone knows the government will bail out the money fund business the next time trouble hit. What the year does is buy the authorties time to come up with a new regulatory scheme that takes into a account the federal government's explicit guarantee of our short-term savings.

For more information, check out Tess' conversation on money market funds with Marketplace' s Amy Scott on this week's Marketplace Money.

09/19/08 by Chris Farrell

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Tax exempt money market mutual funds

Question: I have a municipal mm mutual fund with Fidelity. It is spread across all 50 states. The prospectus shows that for instance Lehman is the "liquidity facility" sometimes Bof A is mentioned or Morgan or JP Morgan Chase. What does that mean about the safety of this mm fund? Susan, Irvine, CA.

Answer: Right now, money market mutual funds are among the safest parking places for cash available. That's because the U.S. Treasury has decided that the American taxpayer backstops the business. The details are still being worked out, but the guarantee is that any publically traded money market mutual funds won't "break-a-buck," the financial pledge that at a minimum the dollar you've invested in a fund will be worth at least a dollar tomorrow. Funds will pay a fee to participate in the program, and the insurance plan has been funded with up to $50 billion. It only includes money invested before Sept. 19.

The Treasury has also clarified that the insurance pledge includes tax exempt money market funds. So, your very short-term fund has the protection of diversification (across all 50 states), the financial soundness of Fidelity and the Treasury's insurance guarantee.

The Federal Reserve has also adopted several rules to make sure that there is sufficient liquidity in the market. (More liquidity means it is easy to buy and sell assets at their fair market value, and less liquidity means it gets harder to buy and sell.)

09/22/08 by Chris Farrell

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Money market mutual funds

Question: I have been told that I should transfer my cash into treasury money market funds (MMF) to protect them during the current crisis. As of now MMF's are not insured or backed by the goverment. Should I assume that treasury MMF's are safe since they are invested U.S. treasury notes? George, Baltimore, MD

Answer: Right now, the savings parked in money market mutual funds before September 19th is extremely safe. In essence, to stop a modern run on the Wall Street bank--an investor flight from money market mutual funds--the Treasury decided to backstop the $3.5 trillion business with the full faith and credit of the American taxpayer. Call it the Federal Money Market Mutual Fund Insurance Corp.

The regulatory rules of the new insurance fund are still being drawn up, the government is determined the traditional industry pledge that net asset value on money funds won't "break a buck" will hold. The dollar you put into a taxable or tax exempt money market mutual fund before September 19 will be worth at last a buck when you withdraw money from the fund. I've long argued for savers to use the money market mutual funds that invest heavily in Treasuries. Why take a risk with your emergency savings money? You want it stashed in a safe haven.

09/25/08 by Chris Farrell

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