A Money Market Fund Is Not Invulnerable

A money market fund is considered one of the safest forms of investment available in the market today. However, it is not invulnerable, and investors should realize that there is some risk involved with this type of fund. Here are some things to consider about money market funds and how they could lose value.

Bad Debt

Most of the time, the majority of money market funds are made up of T-bills, CDs and other forms of low-risk investments. However, some money market funds also include commercial paper and other types of business loans. These loans are considered very low risk and are typically secured by some of the best companies in the market. Nevertheless, sometimes the companies that have more money file for bankruptcy. In such a case, if the money market fund holds the debt, this could result in significant losses for the portfolio overall.

September 2008

One such occurrence was in September 2008. This was during the beginning of a financial crisis in the United States. At this time, Lehman Brothers Holdings, Inc., filed for bankruptcy. They were thought to be a very solid company, and several money market funds held significant investments in them. The Reserve Primary Fund wrote off a significant amount of debt that was owed to them by Lehman Brothers Holdings. This resulted in the share price of Reserve Primary Fund falling to $.97 per share. Whenever a money fund falls below a dollar, this signals trouble for the investors. In that case, it almost caused a run on the bank when investors started to get scared.

Rare Occurrence

Although this occurred in 2008, this is a very rare occurrence in the market. Most of the time, money market funds will keep their share price at a dollar or above at all times. It is very rare for their share price to ever lose value; however, it can happen. Therefore, as an investor, you need to keep this in mind and make sure that you understand there are some risks involved.

Highest Interest Rates

When searching for a money market fund, many investors will seek out the fund that promises the highest interest rates. Although this sounds like a good strategy, it may not be your safest one. While the majority of money market funds are made up of safe T-bills and CDs, others take on bigger risks in order to bring a slightly larger return for the portfolio.

Fund managers may take on additional sources of commercial paper, thinking that the companies behind the paper are solid companies. This may gain them .1 percent in extra returns overall. However, in order to gain this extra percentage, the portfolio has to take on unnecessary risk. As an investor, you want to be a little more skeptical when one money market fund is promising higher returns than the rest of the market. This typically means that there is a higher risk involved.

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