How to protect your money:
- Don't base money market fund selection solely on yield or convenience.
- Read the prospectus.
- Understand the investments in the fund.
- Know that money market funds are not insured by the FDIC.
Consumers shouldn't be blind to the fact that investing in a money market fund does involve some risk. Too often people pick a money market fund based on convenience or yield instead of taking a look at the underlying investments. Many money market funds sought higher-yielding investments such as subprime mortgage-backed securities the past couple years and got in trouble when those securities defaulted. High-yield funds don't get those yields by investing in government securities.
Standard & Poor's says there are approximately 2,000 money market mutual funds, of which some 1,200 are taxable. Within the taxable universe there are about 700 that can invest in commercial paper; the remaining 500 would invest in government securities.
Know your funds
"You need to know what type of funds you own," says Peter Rizzo, director of the fund rating group at S&P. "If it's a Treasury or government agency then, obviously, it would not have any commercial paper. But if it's a prime or a general purpose type fund, it could have commercial paper, although not all do. Typically the makeup of the 200 funds that we rate, that can buy commercial paper, is 40 (percent) or 50 percent commercial paper and the rest in repo (repurchase agreements), Treasury, agencies, bank paper and a cornucopia of other money market investments."
Keep in mind that unlike money market accounts, money market funds are not insured by FDIC or the Securities Investor Protection Corp., known as the SIPC.
Herb Hopwood, president of Hopwood Financial Services in Great Falls, Va., says public perception remains a large part of the issue. "They can put everything out there -- not FDIC-insured and the like -- but when (consumers) see Bank of America they think they're absolutely safe and that a money market fund has no risk whatsoever."
Hopwood advises individuals to stick with funds backed by the larger organizations and to check the yield at least once a week during times like these. Significant drops could be an indication that the fund is taking a hit and is decreasing yield to make up the difference.