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Money Market Funds: No-Brainer, or No Brains?

Be careful! Not all funds are insured.

By Joan E. Lisante
ConsumerAffairs.com

October 25, 2007

Many moneyed souls have their bucks sitting in taxable money market funds, whose assets have reached a record $2.438 trillion, according to Reuters. It makes sense, since most consumers think of money market funds as unsexy, low-yield vehicles in which to park extra cash. They also think they'ree about as safe as that plastic piggy bank you kept on your dresser at age eight.

But as George Gershwin once noted, “It ain’t necessarily so.”

For one thing, all money funds aren’t created equal. There are two basic types:

• Interest-earning money market accounts, typically issued by banks, insured up to $100,000 each by the Federal Deposit Insurance Corporation (FDIC). (Coverage on qualified retirement accounts jumps to $250,000 per account.)

These must be designated “money market deposit accounts” (MMDAs) to qualify for FDIC coverage. They operate like checking accounts, but have a minimum balance requirement and limit the number of transactions you can make in a month.

• Money market mutual funds (MMMFs,) are not FDIC-insured. Money market mutual funds invest in short-term securities issued by the U.S. Treasury, banks and corporations.

The Investment Company Act of 1940 (rule 2a-7) provides that at least 95% of money market mutual fund assets must be invested in “first-tier” investments (AA or AAA-rated securities.) Yields for both money market deposit accounts and money market mutual funds can vary with the market, unlike CDs, which have a fixed yield/interest rate.

Why worry?

So what’s the problem with these “plain vanilla” investments? Chasing higher yields, some money market funds have ventured into hostile territory, jeopardizing investors’ calm expectations of no-sweat income.

If the term “structured investment vehicle” (SIV) doesn’t mean anything to you, listen up. SIVs borrow money short-term and use it to lend long-term, planning on profiting from the “spread,” or difference, between interest rates.

Here’s the rub: investors, scared of SIVs’ long-term investments in mortgage-backed securities, have stopped lending short-term money to SIVs. Blame the subprime mortgage debacle, for starters.

Result: with SIVs shaky, many funds have trimmed SIV-related purchases or allowed instruments to mature without investing in new debt from the issuer. To shore up the market if SIVs show signs of tanking, the U.S. Treasury and Wall Street are attempting to assemble an SIV- bailout fund. Stay tuned and don’t throw out the financial pages.

Protecting your bucks

The FDIC insures bank and savings bank deposits, and the National Credit Union Share Insurance Fund (NCUSIF) insures credit union accounts for the same amounts.

Individual accounts are insured up to $100,000, while retirement accounts have a $250,000 limit.

Here are some tips to make sure that your bank or credit-union holdings are fully covered:

• Break it up. If you’re fortunate enough to exceed the $100,000 insurance limit, you can still ensure full FDIC coverage by either breaking the total amount into $100,000 increments (for example, for a $200,000 nest egg, putting $100,000 into a wife’s name and $100,000 into a joint account for a husband and wife.) Most banks offer many types of accounts, including individual, joint, testamentary (“pay on death” or living trust accounts with a named beneficiary,) and retirement accounts (Roth IRA, Simplified Employee Benefit/SEP, Keogh, etc.)

• Split it. An alternative: split your savings among several institutions, keeping each account below the insurance maximum.

• Check it out. If you bank online, confirm that your bank is FDIC-insured. Read important information about the bank posted on its Web site. The FDIC maintains an online database of institutions it insures. (See www.fdic.gov) Be aware that online and bricks-and-mortar divisions of the same bank may have different names, but be considered one entity for insurance purposes.

• Ask EDIE. Use FDIC resources to tally your coverage, including “EDIE,” the FDIC’s Electronic Deposit Insurance Estimator. EDIE estimates your insurance coverage based on your answers to a series of questions about your accounts. It’s simple to use and can be accessed at the FDIC’s Web site.

• Keep track. Check into your coverage regularly. Sometimes accumulated interest, a new deposit or a windfall (inheritance, insurance settlement, etc.) can push your funds over the insured limit. You then need to re-structure the account to ensure full coverage.

• Bank consolidation. If you maintain accounts at two banks that merge, and combined funds exceed $100,000, you have a six-month “grace” period during which all funds are insured. Be sure to review the situation before the grace period expires and adjust fund distribution, if necessary. Your banker can help with this.

Pay attention!

All money market funds are not alike. It's up to you to keep careful track of what type of money market your funds are in, and how each earns its interest. Know what’s insured and what isn’t. And a common-sense bit of advice: don’t invest in anything you can’t understand. If you're not comfortable being without insurance, don't leave your money in a money market mutual fund.

If all this makes you nervous, have a talk with your financial advisor. If you don't have a good financial advisor, this might be the time to find one, but that's a subject for another day.

Resources

• Federal Deposit Insurance Corporation (FDIC) Toll-free: 1-877-275-3342
• FDIC’s Electronic Deposit Insurance Estimator (EDIE)
• National Credit Union Administration (703) 518-6300, Consumer Assistance Hotline: 1-800-755-1030
• To track returns on money market funds: www.iMoneyNet.com

Joan E. Lisante is an attorney who writes frequently on consumer issues.

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