ARE MONEY MARKET FUNDS A SAFE BET
Money market funds, regarded as a safe and liquid haven, went through a period of immense stress and strain in 2008 and 2009 as investors (read institutional investors) withdrew money in large chunks and precipitated a crisis. Within two days, investors had withdrawn $210 billion from the Reserve Primary Fund as its net asset value dipped below $1. It required the intervention of the US treasury in the form of guarantees to bail out these funds.
Investing is all about understanding your risk-return profile and asset allocation. It is worth recalling that when the markets tanked in early 2008, no asset class was spared and the only safe option at that point in time perhaps was cash. Even holding cash was fraught with risks as the dollar became highly vulnerable.
Federal insurance cover for deposits into money market funds which was to end on December 18, 2009 has just been extended by the Federal Open Market Committee (FOMC). According to Crane Data, 95% of the $3.4 trillion in money market assets is covered by this guarantee which now lasts till February 2010. Remainder of the assets is in treasury assets and government-only funds which are believed to be secure.
If you are investing in money market funds in 2010, make sure the fund is insured like funds from Fidelity, Vanguard, Schwab and T Rowe Price. Even if money market funds are not as secure as money market bank savings accounts, they are favoured by large institutional investors for parking their short term liquidity. Money market funds create additional demand for short term corporate bonds and commercial papers and It is more or less certain that money market fund reforms will ensure that investor interest does not suffer. It is in the government’s interest to ensure stability and liquidity for these funds to operate at an optimal level.
Does that mean money market funds are safer now than they were in the last quarter of 2008 when dark clouds had engulfed the financial markets? The answer is not that simple. For most retail investors, safety of principal is a poor cousin of return expectations. As the stock market revives in 2010, mirroring a widely expected economic recovery in the US, investors would be better off moving ahead the risk spectrum towards fixed income bonds. Equities would be the best bet for those thirsting for higher returns to counter the burden of inflation.