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Will Money Funds Finally "Break the Buck"?

When stock market jitters become too much for investors, they can always retreat to the safety of money funds. Yet even some of the safest places for your money are apparently at risk, as some money funds had invested in securities including subprime mortgages.

Money fund investors have historically taken one thing for granted: They'd be able to get all their money back no matter what. As credit problems have started creeping into the safest of investments, fund companies have so far done their best to keep their money funds from hurting investors by stopping them from "breaking the buck."

That term refers to the fact that most money funds trade at a constant value of $1 per share. Theoretically, if money funds suffer credit-related losses, investors have no guaranteed right to receive that $1 -- as little as a 1% loss could force the fund to "break the buck" and trade at $0.99 per share.

Stopping the fear flight
So far, many financial institutions have taken steps to shore up their money funds, despite the risk of losses. Bank of America (NYSE: BAC  ) said last week that it plans to provide $300 million to protect the funds its retail customers use. Others, including Wachovia (NYSE: WB  ) and Legg Mason (NYSE: LM  ) , have taken similar steps.

Meanwhile, other firms, such as Wells Fargo (NYSE: WFC  ) , have chosen not to take any action -- at least for the moment. Yet for any money fund, the pressure to maintain a $1 net asset value is huge. Failing to do so would almost certainly cause a rapid, almost fearful, outflow of assets not just from a firm's money funds but from funds in all categories, jeopardizing the firm's entire money management business.

Playing chicken with your money
Even though money fund managers have strong incentives to make you whole even if their funds suffer losses, that's not something you can take to the bank. Although no fund would want to be the first to break the buck, the bad news for investors is that this concern wouldn't necessarily stop the funds -- especially if it appeared likely that several other funds would follow suit. Already, an institutional fund offered by General Electric (NYSE: GE  ) has told investors that they will get only 96% of their money back.

If you want complete assurance that you won't lose any money, you have a few choices. You can move your money to an FDIC-insured bank account. (Money funds are not insured by the FDIC nor the SIPC; however, money market accounts at banks are insured by the FDIC up to $100,000.) Also, many fund companies offer money funds that invest solely in Treasury bills, which have no credit risk.

The downside is that moving your money can cost you income. Treasury money funds, for instance, have yields that are almost a full 1% lower than what you get from more general money funds. That may not be too high a price to pay for protection -- but it is a cost.

Check it out first
Before taking action, you should look at your particular money fund to see if there are any potential problems. Often, funds separate out their holdings into categories, making it easy to find asset-backed securities and other complex investments that have been the source of the current problems. In other cases, you may have to dig more deeply through prospectus information or annual reports to find out what your fund owns. Either way, don't hesitate to ask your broker or fund representative to explain the risks involved.

There's still a good chance that average money fund investors will emerge unscathed from the credit crisis. (To date, only one money fund has ever failed, back in 1994.) Yet it's always a good idea to understand where risks in your portfolio might be hidden -- especially when they're in a place you'd least expect to find them.

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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