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Rate cut adds up to trouble for some money market funds

Fed rate cuts may or may not help the ailing economy, but they're definitely not what the doctor ordered for your money market fund.

Rate cuts that make it cheaper to buy a mortgage or car loan also cut the return on interest-based investments such as money market funds.

"Income investors have been getting punished for two years, and these lower rates are doing more pain than good," says Peter Crane, vice president and managing editor at iMoneyNet, provider of money market mutual fund data. "The buying power of savers has been reduced by hundreds of billions of dollars since the beginning of 2001."

The Fed's decision to cut the Fed fund rate by a half percent probably will take a few weeks to affect most money market funds. Some fund companies will have tough decisions to make, Crane says.

"A half-percent cut means 70 or 75 funds will drop below 1 percent. We're still only talking about the funds with the highest expenses. Thirty funds are below a quarter point. They'll have to waive expenses to stay above zero."

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A negative yield, meaning no return on your investment, is different from the often written about "breaking the buck." Breaking the buck means that the net asset value, the price per share, of the fund drops below $1.

If the yield sank into negative territory and, instead of waiving expenses, the company deducted them from the NAV; the dollar would be in danger.

Only once has a money market fund's NAV dropped below a dollar.

In 1994, Community Bankers U.S. Government money market fund, which invested in risky derivatives, liquidated when its NAV fell to 94 cents. The industry made up the difference to investors so no one lost principal.

Money market funds are not FDIC insured, but the Securities and Exchange Commission now strictly regulates them. Funds are primarily limited to high-quality, short-term debt, such as Treasury bills.

Peter Rizzo, head of Standard & Poor's money market mutual fund ratings team, says he expects any fund that has a negative yield will waive fees.

"They want to maintain the stability of the fund. Would you want to put your money in a fund that didn't do that? It's their reputation. I can't foresee any companies that would have a tough time waiving fees unless it's a small investment shop that needs the fees to survive."

If you want to avoid buying a money market fund from a small shop that needs the fees to survive, you may want to check out Standard & Poor's money market fund ratings.

The company rates money markets on credit quality, market price exposure -- the potential for a decline in the market value of the fund's assets -- and management. S&P only ranks the funds that ask the company for a rating. Most receive the top rating of AAA, but you will see some As and even a B here and there.

"Consumers should look at the overall credit quality of the investments the fund buys and the maturities. You also want the management team to be experienced. Some shops might put their least experienced manager on a money market fund because it's not a sexy fund. You have to read the prospectus," Rizzo says.

It's always smart to look for a money market fund that has low fees. Why have your yield gobbled up by fees? But also, a fund that charges just a quarter percent in expenses will have a better chance of avoiding negative yield problems than a fund that charges 1 percent. The average fee is about half a percent, but many can be found at a quarter percent or less.

-- Posted: Nov. 8, 2002

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