 Do money markets protect your principal?
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 Dear
Dr. Don,
If I put money into the money market, is there a chance that I could
lose that principal?
-- Tyler Trade-off
 Dear
Tyler,
It's easy to get confused about how safe your money market investments
are, especially when the typical bank now offers both banking and
brokerage services under the same roof.
The first distinction I make is whether the investment
is classified as a deposit with the bank and is covered by FDIC
insurance, or NCUSIF insurance if you're banking with a credit union.
I classify these investments as "bank products," and they
are insured up to the limits of that insured coverage. A money market
account, or MMA, is an insured deposit just like a CD, checking
or passbook savings account.
A money market mutual fund, or MMMF, is not a bank
product and is not covered by deposit insurance. Instead, you are
purchasing shares in a mutual fund that invests in money market
securities. Money market investments are short-term debt obligations
with a final maturity of less than one year. Shares of money market
mutual funds are priced at $1 per share. The yield from the investment
comes in the form of interest earnings, not capital gains from rising
share prices.
Investment managers of money market mutual funds work
very hard to not "break the buck" by keeping the value
of a fund share at $1. A fund's investments can lose value, and
that loss in value can cause the share price to decline -- breaking
the buck.
The risk to principal with a money market mutual fund
depends on the risk that the investment manager takes on in investing
the money in the fund. A money market mutual fund can invest solely
in obligations of the federal government that are considered to
be virtually risk-free, or they can invest in the short-term debt
of corporations and take on a measure of risk that the corporation
won't repay that obligation. Funds with longer average maturities
also have higher interest-rate risk.
Money market mutual funds are also delineated by whether they invest
in taxable securities or tax-exempt municipal securities. With a
taxable fund you will owe federal and state income taxes on the
interest income, but with a tax-exempt fund you won't owe any federal
income tax on the interest income and may or may not owe state and
local income taxes on the interest income, depending on how the
fund is invested and the tax laws of your state.
You can use Bankrate to compare
rates both locally and nationally for money market accounts
and money market mutual funds. The mutual funds are segregated by
taxable and tax-exempt funds.
An FDIC- or NCUSIF-insured deposit with a bank or
credit union is backed by the full faith and credit of the United
States government, and you face no loss of principal. Deposits over
the insurance limit carry some risk of loss.
Money market mutual funds that invest solely in U.S.
government securities have minimal risk to principal but how the
fund invests does impact the risk to principal.
Money market mutual fund investment managers work
very hard to not break the buck, but the more risk you take on when
investing, even when investing in short-term debt, the greater the
possibility that you could lose principal.
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