The sharks are circling around Charles Schwab (Nasdaq: SCHW), now that the discount broker's ultra-short bond fund is tanking.

Schwab YieldPlus (FUND: SWYPX) is attracting more class action lawsuits than investors lately. The fund, marketed with the objective to "seek high current income with minimal changes in share price," has begun to stretch the definition of "minimal changes" in its Net Asset Value.

If shareowners are peeved to find that the fund's monthly income wasn't enough to offset its decline in NAV last year -- with its total return off by 1.3% in 2007 -- they'll positively lose it by the end of this quarter.

Through yesterday, the fund's NAV had fallen by 17.1% this quarter -- a total drop of 16.2%, once you tack on a pair of $0.04-a-share monthly distributions. It would take roughly three years of dividend checks to offset what the fund has relinquished in less than three months, and that's assuming a stable share price and monthly dividend.

It's easy to see why the lawyers are drooling, and why the fund's days are numbered. Since its inception in 1999, the fund's annualized return was an already-anemic 3.4% through the end of last year. That figure will get crushed once the returns are updated next week to include this bloodied quarter.

The fund is unlikely to survive at that point, for several reasons:

  • How do you market historical returns when they become hysterical returns?
  • Can Schwab afford to have its brand name attached to a stinker?
  • The fund's asset base has shrunk from roughly $13 billion in May to $2.5 billion. Those defections will likely continue once the last of the bagholders realizes how quickly this presumably "low risk" investment gets tagged as a "high risk" vehicle by Morningstar in Schwab's own fund information page.

Chasing yields can be a dangerous pastime. Just ask income-happy investors who hopped onto shares of companies like Thornburg Mortgage (NYSE: TMA) or Citigroup (NYSE: C), under the false assumption that chunky payouts are price-support mattresses. Dividend investing is never about just a round yield. Newsletters like our own Income Investor emphasize the health of the companies behind the distributions. After all, valuations can fade, and dividends can get slashed.

This is an important lesson, especially now that the Fed's string of rate cuts makes it ever harder to find a place to park cash. One can only imagine the calamitous outrage that would break out if money market funds, typically pegged to a steady $1 NAV, began to break the buck. It's only happened once -- to a tiny fund 14 years ago -- but heavies like Bank of America (NYSE: BAC) and Legg Mason (NYSE: LM) have already made preemptive moves to fortify their money-market funds.   

For risk-averse investors -- those who falsely believe that they're savers, when they're ultimately investors -- that space beneath the mattress is starting to look like a pretty appealing free parking space.

Charles Schwab is a Motley Fool Stock Advisor recommendation. Legg Mason is an Inside Value pick, and Bank of America is an Income Investor selection. A free trial subscription to any of these newsletters is waiting with your name on it if you want to learn more.

Longtime Fool contributor Rick Munarriz has been trading exclusively through discount brokers since 1990 but he does not own shares in any of the companies in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.