Money Market Accounts versus Money Market Funds
January 17, 2009
Many people confuse market funds with money market accounts. But these are two very different things. Money market funds are investments in the debt of governments and major corporations. Money market accounts are much more like savings accounts.
Safety Concerns
For years--decades, even--money market funds were marketed and sold as the ultimate safe investment. And this was not a misrepresentation. They were safe. Only twice in 40 years did the value of a money market fund decline below the amount invested in it. But then, recently, the so-called "credit crunch" grew into something quite scary. And people began to worry that good old stodgy, secure money market funds were in trouble. Panic and confusion took hold.
The reason money market funds are so historically safe is that fund managers were very careful and conservative about which debts they buy. Only the most secure debt was invested in, much of it issued by the federal government. Thus, yields were low. But the money itself was safe, because the underlying debts were going to be paid back.
In recent years, however, some money market managers, in pursuit of higher returns, began to invest in riskier debt. When the credit markets deteriorated, a lot of this riskier debt was suddenly not necessarily going to be paid back--seemingly putting money market funds at risk.
To address this problem, investment firms and the government moved to guarantee the safety of these investments. The panic subsided, and investor losses did not occur.
So, as of today, how safe are money market funds? Because they are investments in assets, it really depends on the quality of the assets. There certainly are some corporations with debt that is not credit-worthy. But there are also plenty of corporations with credit-worthy liabilities.
Furthermore, the historically conservative attitude of money market fund managers has returned with a vengeance. Money market funds are going back to their roots as boring but safe investments offering relatively low rates of return but almost no risk of loss.
Investors who are worried about the safety of money market funds need to accept this equation. For example, if you see that one money market fund is paying five percent, whereas all the other ones are paying four percent, you can assume that the underlying assets of the former entail more risk than those of the latter.
Money market accounts, by contrast, are basically savings accounts. The money is simply deposited in the bank and gains interest, and is insured up to $250,000 by the FDIC. The problems in the credit market have not affected money market accounts whatsoever. In the case of money market funds, fear of major losses turned out to be just that: fear.
Sources
Loth, Richard. "Do Money Market Funds Pay?" Investopedia.
Pitt, David. "Money Market Funds Proclaim They're Secure." Associated Press. September 18, 2008.
