How Safe are Money Market Funds

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A money market fund is actually a kind of mutual fund that invests in debt instruments such as commercial paper or government bonds rather than stocks. Despite what some people think money market funds are not necessarily any safer than exchange traded funds or regular mutual funds. It is entirely possible to lose everything that you invest in one.

 

Why Money Market Funds are not as Safe as You Think

The first thing you should be aware of is that money market funds are not bank accounts so they are not guaranteed by the Federal Deposit Insurance Corporation. Nor are they backed by insurance companies and guaranteed by state governments the way annuities are. That means you can lose all of the money that you invest in one if something goes wrong in it.

 

A money market fund is only as good as the securities that it invests in. If a money market invests in US Treasury bonds or the debt or commercial paper of certain corporations such as major insurance companies it can be very secure. If a fund invests in junk bonds or mortgage-backed securities it may not have any security at all. Many securities are actually less secure and more dangerous than stocks are.

 

The Great Financial Meltdown of 2008 was caused by the collapse of mortgage backed securities. At that time some money markets became so insecure that the federal government actually set up special guarantees to keep them from collapsing. So money market funds can be very vulnerable to financial crises.

Unlike stocks there is a strong possibility that some of the investments will never come back.

 

In addition to mortgage backed securities government debt such as municipal bonds and foreign government bonds can lose value. During the summer of 2011 some financial experts even questioned the security of US Treasury bonds because of a political crisis over the debt ceiling in the US Congress.

 

How to Use Money Markets as an Investment

What this means is that a money market may not be as secure an investment as many people think. It could obviously very dangerous for a person to put all or most of his or her retirement nest egg in one. There could be better or cheaper alternatives.

 

Investing in US treasury securities directly could obviously be cheaper. Yet it would not give you a very high return and you probably want a higher return so you’ll have more money after you quit working. Another problem with money markets is that since they are debt instruments they can have rates of return that are lower than inflation.

 

Good good-stock based mutual funds or exchange traded funds could give you a higher rate of return and a similar level of security. An S&P index fund will usually give you a 12% rate of return of each year. You can invest in one through a variable or indexed annuity which will give you tax-deferment and the security of a fixed rate annuity. One big advantage to annuities is that yearly gains will be invested in a tax deferred annuity to increase the size of your investment.

 

Money market funds seem like a dubious investment. They offer all the hazards of mutual funds with none of the advantages such as a higher rate of return.