Be careful where you put your rainy day fund.
I didn’t expect to see the day when I’d question where we’ve been keeping our cash. For almost two decades, it’s been sitting in a money market mutual fund (MMF) in an investment institution, growing at a snail’s pace. Well, the last couple of weeks, my spouse has been anxious about some stuff he’s read at Calculated Risk (one of his favored blogs) and other housing gloom-and-doom type blogs he seems to be addicted to. On top of that, these days, the news in The Economist is making him edgy.
The Risks of Money Market Funds
#1 Breaking The Buck
He alerted me to the concern in the financial arena about money market funds possibly “breaking the buck”. Money market fund shares are valued at $1 a share and are deemed very stable. But not all such funds are alike. There are those that may have invested in riskier paper to gain higher yields. And we all know what happens when a fund invests in “something risky” — there’s a chance that a stable value fund’s share price falls below a dollar.
Since summer, problems have cropped up in several large money-market funds, showing that to achieve higher returns and attract more customers, some money-market managers may have been investing in riskier holdings.
Earlier this month, Wachovia Corp. of Charlotte, N.C., disclosed a $40 million loss tied to money-market funds at its Evergreen Investments unit in Boston. Evergreen’s largest money-market fund holds a stake in at least one of what are known as “structured investment vehicles,” or SIVs, complex financial instruments that have become difficult to trade as credit problems have spread throughout the economy since the summer.
In all likelihood, big funds such as Vanguard, Fidelity and the like will not be affected. They have the resources to “bail out” any such losses experienced by their cash funds. It is within their interest to do so if there is threat of loss, since they would otherwise risk the possibility of panic selling by investors from these accounts. But this does not change the fact that losses are already occurring throughout the financial world:
Bank of America said yesterday that it would provide as much as $600 million to prop up several Columbia Management funds, which bought large amounts of debt issued by structured investment vehicles, or SIVs, that is now worth less than it paid.
Credit Suisse said it had booked about $125 million in unrealized losses after it bought notes issued by collateralized debt obligations and SIVs in its money market fund. The Wachovia Corporation said it had made a similar pre-emptive strike, recording a $40 million loss to buy distressed notes from its Evergreen money market fund. Legg Mason, SEI Investments and Sun Trust Banks have each secured letters of credit suggesting that they might be willing to lose money before investors in their cash funds do.
#2 Freezing Fund Withdrawals
One more thing: what about that Calculated Risk story that worried my spouse so much? It’s about a government money market fund that froze its fund withdrawals to prevent mass redemptions. You see, even if a fund is able to solidly maintain its share price, it doesn’t stop nervous account holders from abandoning the fund en masse, which would pose an equally big risk to the fund’s stability.
So my spouse has decided to be proactive and has suggested that we move our emergency money (i.e. cash) out of their non-Treasury based MMF accounts and into something safer. In considering this decision, we’ve decided to go about it logically. If you’re facing the same dilemma, here are some steps you could take:
How To Decide Where To Put Your Cash Today
#1 List your cash accounts.
If you’ve got one such account, then this is easy. But it’s a good idea to make sure you know where all your money is, especially if you tend to be a “fund or account collector”.
#2 Find out where your money is invested in.
Time to review the prospectus to understand the investments in your fund. If there are any structured investment vehicles or mortgage-backed securities in it, flag those accounts for possible redemption unless you want to take the risk of value instability in these accounts.
#3 Know your primary goals for your cash.
You want pure safety? You want convenience? Or higher yield? In reality, we all want these features, but there are tradeoffs. Note that money market mutual funds are not FDIC insured.
#4 Review all options for your emergency fund.
You may decide that you’re not taking any chances, and that the extra partial percentage point increase in money market fund yields is not worth any risk of principal loss whatsoever. For guidance, check out this article from About.com covering emergency funds, including where to place them:
- Checking Account
- Certificate of Deposit
- Money Market Deposit Accounts
- High Yield Savings Accounts
- Money Market Mutual Funds
- Under The Mattress
Looking at these options, we’d immediately eliminate “checking account” from the list since the money isn’t going to be used to pay bills. CD’s are also out of the question since an emergency fund needs to be in a liquid location and should be easily accessible, not stuck in something you can’t redeem suddenly without penalty, such as a time deposit. And I wasn’t being entirely facetious with “under the mattress”, though majority of your money should be elsewhere.
To evaluate the rest of the remaining choices, I turned to Jim at Blueprint of Financial Prosperity, who made a strong case for high yield savings accounts. Following his write-up is a great discussion that revealed opinions from fans of money market funds — who incidentally dismissed any risk in these funds given their rock solid stable returns throughout time vs those who favor the high yield savings accounts.
But given the current economic environment, I’ve recently discovered a few interesting places to put my cash, including a free checking and high yield savings combo account. If that piques your interest, then take a look at the following high-yield accounts available right now:
Checking and High Yield Savings Accounts
- Washington Mutual’s free checking and high-yield savings with a high 3.75% APY.
Here’s some additional info on Wamu Free Checking.
- ING DIRECT will earn you 3.00% variable APY. No Fees and No Minimums!
Check out my review on ING Direct Checking and Savings.
#5 Evaluate your financial institution.
If you’re happy with your bank or financial institution and you trust that they won’t be folding anytime soon, you may decide to keep your money in an account with them which passes your litmus test for safety, convenience and expected returns. In my case, I’m looking for MMF’s that are backed by US Treasuries or US government obligations. If your money isn’t with them already, you may also want to consider going with the big guys (Vanguard, T. Rowe Price, Fidelity, etc). They have the resources to cover any defaults that may be experienced by the underlying investments in their funds.
So what are we doing? Whatever cash we have we’ll consolidate into one account in a big institution and make sure it’s in Treasuries. Especially since right now, this is what we’re living off at the moment.
Other Resources:
How Safe Is Your Money Market Fund
Credit crunch highlights risks in money markets
How Safe Is Your Money Market Fund?
Thought your money market fund was safe? Think again
Image Credit: AOL Money
Good to know about the MMFs. We’re about to start a Roth IRA and still are figuring out where to put it for now (when it hits $3000, I know exactly where it’s going…but it’s not there yet).
While I’m not overly concerned about money market safety, this is a great read.
Oh, and tell your spouse he might want to cut back on the bubble blogs. It’s rather easy to get absorbed in the bad news vortex.
MMF’s have always made me a little nervous so we’ve stuck to MMA’s, though now the bulk of our emergency fund is a liquid CD (higher rate than an MMA, easy to make deposits, one withdrawal per week without penalty). The interest rate at our brick and mortar bank is not as high as an online savings account, but we made convenience and simplicity a higher priority (as in, if something should happen to me, my husband wouldn’t be stressed trying to figure where all the cash is).
I have my money in Vanguard’s money market, and they have sent me a letter saying that their money market funds didn’t invest in the mortgage debt and they’re pretty much all invested in government /muni bonds. I do believe them so I’m keeping my money there. I think it’s good to react when you know the company you’re dealing with is going down the tube, though.
@Everyone,
Breaking the buck has really never happened in the past (okay, maybe you can count the cases in one hand throughout history). So this whole post may sound like an “overreaction”, which to me would seem to be the case since I’ve taken MMF’s and their “risk” for granted for my entire adult life. MMFs have been my cash fund of choice since coming out of college wondering where to put my savings. But I wrote this as a reaction to my husband’s concerns about our money and he makes some valid points, the biggest of which is the following:
In our case, we are not pulling in much of job incomes lately. We’re down to 30% of what we used to earn as a household since my husband went off to be in a startup (which I’ll probably be writing about at some point
). Throw in the fact that I plan to quit my job and cut off our main income stream by middle of next year. We are thus relying mainly on our savings alone to tide us over (until hopefully some kind of money stream from the startup kicks in, whether it be through venture funding or the business itself). This makes us doubly touchy about where we have our money today. Any hint of problems with our cash position, no matter how remote, will make us nervous.
Ordinarily though, I have this assurance to fall back on: the fact that, as explained in this article,
“There has not been a single money market fund that ‘broke the buck’ since 1994.” and that “Nobody wants to be the first to fail.” But then again, as the article suggests, could this be putting extra strain on our financial system? Definitely some thoughts to mull over.
@Mike-TWA,
My husband definitely gets worked up over the bad news. He’s much more bearish than I am, because he’s big on the numbers analysis and gets bogged down with whatever the talking heads dish out. This is probably why our portfolio is much more conservative than I’d like to be. There’s growth in it, but if left to me to entirely decide, it would be a bit more aggressive. We’re aiming for balance, peace of mind, restful sleep and avoidance of huge arguments stemming from market volatility.
I wouldn’t disregard CD’s altogether if you have a substantial cash reserve. For instance, you could buy 6 CD’s for $1000 spaced at 1-2 month increments. That way, if you had an unexpected expense, you could put it on your credit card and the CD would be up before the bill was due. Granted, this would only work if individual expenses were less than $1000, and you need the discipline to reinvest the money into another CD when the term was up, which may be more involvement than people want.
I think a high yeild savings account is the way to go.
Is your spouse one of those people who put their money under the mattress!? For emergency, I think cash(most liquid)is best because it is the fastest.
I got worried there. I just glanced at the picture and thought for a second that the cash was gonna be up the ladies a**e. Phew!!
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Why not high yield online accounts only? They are FDIC insured and money can be accessed very quickly (within a week).
[...] Silicon Valley Blogger at The Digerati Life offered suggested ways to safeguard your rainy day cash. [...]
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I have an online savings with my bank (wamu) and is currently 4.75% for my emergency fund–no minimums and totally free. While I’m not crazy overall with Wamu as a bank, I like that I can access my funds instantaneously by going into a bank or withdrawing the money right away–or transferring it online into my checking.
If access is your concern, an online savings linked to a checking account is the best way–but if you’re concerned with having too easy access, I’d go with ING or another bank that takes a couple days to transfer funds.
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