Money-Market Funds: Now a Safer Haven

Money-market mutual funds traditionally serve as ultra-safe parking places for cash while offering higher yields than regular bank checking accounts. Although deposits have never been guaranteed, there has always been an implicit promise that the value of each share would stay at $1. It was assumed that the financial-services companies that operated the funds would never let the shares "break the buck."

That illusion vanished the week of September 15 when the Reserve Primary fund, which is geared toward institutional investors, incurred losses substantial enough that the value of its shares fell to 97 cents. The fund was heavily invested in Lehman Brothers' commercial paper and notes, which lost most of their value when the firm filed for bankruptcy. (TD Ameritrade announced on September 24 that it would take a fiscal fourth-quarter charge of up to $50 million to cover client losses in Reserve Primary.)

Money-fund shareholders, mainly institutions, became concerned about potential losses and withdrew slightly more than $133 billion from Reserve Primary and other funds between September 16 and September 19. Regulators worried that this could turn into a Depression-style run on the funds. That might have led to a "full-scale meltdown," says Peter Crane, president of Crane Data, which tracks money funds.

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To prevent a run, which would heighten the crest of the ongoing financial tsunami, the Treasury Department announced it would create a temporary insurance system for money funds. To do that, it would use $50 billion in assets from the Exchange Stabilization Fund, which was created in 1934 "to promote international financial stability." The insurance, which covers assets in money funds as of September 19, will last three months and will be available to both taxable and tax-free money-market funds that pay the required fee. The fee hasn't been set yet, but it will be based on a fund's assets.

How will it work? Details of the insurance plan haven't been worked out, but for now one thing is clear, says Crane: "Money funds won't melt down, and the net asset value is safe."

Major fund managers, such as Vanguard, are awaiting particulars, including cost information, before deciding if they will participate in the insurance plan. If Vanguard does opt in, shareholders will be able to call or go online to find out their balances as of September 19.

How can you tell what kind of investments your money fund is holding in its portfolio? It's almost impossible. The assets are so transient that by the time you see a report listing them, they're probably gone.

Don't worry about that. Instead of a fund's assets, concentrate on its yield as a measure of safety. Crane recommends what he calls the wildebeest strategy: "When the lions come, don't be in the front or back of the pack. Move to the middle and you should be safe."

Bigger is better. Sticking with a fund managed by one of the largest financial-services firms, such as Fidelity, T. Rowe Price or Vanguard, is also a good strategy. They have the resources to support their funds if necessary. Fidelity's Select Money Market fund is yielding 2.60%, just a smidgen less than the top fund, TCW Money fund. And with a 2.29% yield, Fidelity's U.S. Government Reserves fund is in first place among funds that invest mostly in government securities.

At 2.25% and 2.34% respectively, the yields of two other fund behemoths, Vanguard Prime -- which has more than one-third of its assets in Treasury securities -- and Schwab Value Advantage, are only slightly lower. (For more details on money funds, see Is Your Money-Market Fund Still Safe?)

The new insurance coverage should reassure investors. If you're still nervous, or if your money fund elects not to participate, you can always move your cash to FDIC-insured bank accounts or certificates of deposit. That's easy at large mutual fund companies, such as Fidelity and Vanguard, which also have brokerages. But you may have to settle for lower yields.