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Plan Well, Retire Well

Saving and investing your money

Can you lose money invested in a Money Market Fund like Putnam?

I turned on the radio for the 12:00 news, and heard that a money market fund had closed and there was fear that other money funds would "break the buck." I figured it was time to review some basics about money market funds and money market accounts.

If you have a money market account at the bank, that's not the same thing as a money market fund. Your money market account is a deposit account and is insured by the FDIC just like your checking or savings account, up to $100,000 - maybe more, depending on how the account is titled. (See the FDIC website for more details on that.)

Money market funds are investments offered by mutual fund companies. They are investments, not deposit accounts. While they are considered to be very safe, they are not insured. There is no guarantee that your money market fund will always be worth $1 per share. But as far as I could determine, there have only been 2 instances in the history of money market funds where investors may have lost any of their investment in a money market fund. That's known as "breaking the buck." If you invest $1 in a money market fund, you expect that $1 value to be stable and to earn interest on that $1. Each dollar you invest is technically buying one share of the fund. The expectation is that the shares will always be worth $1. That's known as "preservation of capital." But it is possible that the value could drop and your shares would only be worth, say, $0.95.

You also expect to be able to take your money out of the fund at any time. That is "liquidity."

Even if the value of the investments in your money market fund drop below $1, your shares might still be worth $1. No, that's not a riddle. No mutual fund wants to taint its reputation as being one of the only 2 or 3 investment companies that ever "broke the buck." So even if the investments are worth less than $1 per share, the investment company may put its own money into the fund to shore up the value and make its investors whole.

Money market funds invest mostly in short term, high quality investments. What does that mean?

  1. Short term: Money market funds generally loan money, or buy debt, that matures in perhaps 365 days or less. The weighted average maturity could be much less - perhaps just 90 days. The idea is that there you can better estimate the risk of a company or government agency defaulting on a loan that they have to pay back in the very near future, compared to a loan that doesn't come due for several years. The financial position of a company shouldn't change much over the course of a few months, while it might change dramatically over a period of years.
  2. High quality: The money market fund should be buying the debt or obligations or companies, banks, or government entities that have a very good credit rating according to rating organizations such as Moody's or Standard & Poor's. That should mean that there is a very small risk that the company or entity will be unable to pay the interest or repay the debt. Some funds invest almost exclusively in government securities that are backed by the full faith and credit of the US government. Others invest most of their money in securities of well-rated companies.

Read the prospectus of your money market fund to see what it's investment policies are - for example, what percentage of its money should be invested in government securites. The annual report should give the average credit rating of the fund's investments and the proportion of the fund's assets that receive each credit rating. For example, 45% of the assets might have a rating of Aaa (the top rating), 52% a rating of Aa and the remainder a rating of A.

Each organization that rates the creditworthiness of companies uses a slightly different nomenclature. AAA is Standard and Poor's top rating; A++ is the highest rating of A.M. Best, and and Aaa is the top rating from Moody's. Click on those links to see the nice explanations or each company's rating system at Wikipedia.

Should you be worried about your investment in a money market fund? Based on past history, it is very unlikely that you'll lose any money in a money market fund. Is there any guarantee? No. You might consider whether your fund has been paying a significantly higher interest rate than other funds, which could indicate they were investing in somewhat riskier securities. Or look at the credit ratings of its investments compared to those of other money market funds. If you are planning to use those funds to pay for something in the near future, such as college tuition for this fall or home remodelling that's underway, you might want to be extra cautious and move just that amount into an insured account at a bank.

I personally plan to leave my money market fund investment where it is. I am not counting on it to pay bills or other planned expenses in the near future. The company has a reputation of serving its customers well and being ethical. There's always a chance that I could be wrong, but I think it's very unlikely that I will lose any money.

Do you have additional questions about money market funds, credit ratings, or other financial issues in the new? Email and let me know. Click on my name below. I'll post some of your questions and comments for others to view.

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