Money market funds are low-risk mutual funds that are popular with risk-averse investors. Like any mutual fund, a money market fund can lose money. Federal regulations and brokerage insurance coverage provide a degree of protection for money market funds. However, even with these safeguards in place, investors must contend with a degree of risk.
Money Market Funds
Money market funds were originally designed to provide investors with a relatively safe alternative to interest-yielding bank accounts. Like any mutual fund, a money market fund is comprised of a pool of securities. Funds contain short-term bonds, certificates of deposit and other low-risk securities such as commercial paper. Short-term securities are not prone to major price fluctuations. Consequently, money market mutual fund share prices typically remain steady at precisely $1 per share. In 2013, the United States Securities and Exchange Commission estimated the total net asset value of money market funds at close to $3 trillion.
Bondholders must contend with default risk. Cities, corporations and even national governments have become insolvent or filed bankruptcy in the past. When this occurs, bondholders may lose some or all of their investment. Consequently, a money market mutual fund loses money if the bonds and other securities within its portfolio drop in value. Such an event causes the value of the fund to decrease and the share price falls below the $1 mark. Investment professionals refer to this rare event as "breaking the buck." In 2008, the Reserve Primary Fund broke the buck. Panicked investors responded by pulling $300 billion from other money market funds, according to the SEC.
In response to the financial crises of 2008, the United States Department of the Treasury created a money market fund insurance program. Participating funds paid premiums to the Treasury Department and investors were assured of insurance payouts on losses caused when funds broke the buck. The Treasury program had a positive impact and the market soon stabilized. In September 2009, the Treasury Department opted to discontinue the insurance program. As of now, neither the federal government nor any other agency offers principal protection or insurance on money market funds.
Most brokerage firms in the United States belong to the Securities Investor Protection Corporation. The SIPC insures assets held by member firms up to $500,000 per investor, per firm. If you jointly own a brokerage account then your insurance coverage extends to $1 million. The SIPC covers losses related to your brokerage firm becoming insolvent. The SIPC does not insure losses caused when your money market fund drops in value.
In 2010, the SEC took steps to protect money market investors by passing new rules that limit risk taking by fund companies. A 2012 SEC study found that government-bond money market funds are less susceptible to price drops during a financial crisis than other kinds of money market funds. Based on the study, the SEC made a series of yet-to-be passed proposals designed to make share trading and pricing processes more transparent.