Why Money Market Funds Break The Buck (2024)

Money market funds are often thought of as cash and a safe place to park money that isn't invested elsewhere. Investing in a money market fund is a low-risk, low-return investment in a pool of very secure, very liquid, short-term debt instruments.

Money market funds seek stability and security with the goal of never losing money and keeping net asset value (NAV) at $1.This one-buck NAV baseline gives rise to the phrase "break the buck," meaning that if the value falls below the $1 NAV level, some of the original investment is gone and investors will lose money.

However, this only happens very rarely, but because money market funds are not FDIC-insured, meaning that money market funds can lose money.

Why Money Market Funds Break The Buck (1)

Insecurity in the (Money) Market

While investors are typically aware that money market funds are not as safe as a savings account in a bank, they treat them as such because, as their track record shows, they are very close. But given the rocky market events of 2008, many did wonder if their money market funds would break the buck.

In the history of the money market, dating back to 1971, less than a handful of funds broke the buck until the 2008 financial crisis. In 1994, a small money market fund that invested in adjustable-rate securities got caught when interest rates increased and paid out only 96 cents for every dollar invested. But as this was an institutional fund, no individual investor lost money, and 37 years passed without a single individual investor losing a cent.

In 2008 however, the day after Lehman Brothers Holdings Inc. filed for bankruptcy, one money market fund fell to 97 cents after writing off the debt it owned that was issued by Lehman. This created the potential for a bank run in money markets as there was fear that more funds would break the buck.

Key Takeaways

  • In a money market fund, investors are buying securities, and the brokerage is holding them.
  • In a money market deposit account, investors are depositing money in the bank.
  • In a money market deposit account, the bank is investing it for itself and paying the investor the agreed-upon return.
  • The FDIC does not insure money market funds. It does guarantee money market deposit accounts.

Shortly thereafter, another fund announced that it was liquidating due to redemptions, but the next day the United States Treasury announced a program to insure the holdings of publicly offered money market funds so that should a covered fund break the buck, investors would be protected to $1 NAV.

Many brokerage accounts sweep cash into money market funds as a default holding investment until the funds can be invested elsewhere.

A Track Record of Safety

There are three main reasons that money market funds have a safe track record.

  1. The maturity of the debt in the portfolio is short-term (397 days or less), with a weighted average portfolio maturity of 90 days or less. This allows portfolio managers to quickly adjust to a changing interest rate environment, thereby reducing risk.
  2. The credit quality of the debt is limited to the highest credit quality, typically 'AAA' rated debt. Money market funds can't invest more than 5% with any one issuer, except the government, so they diversify the risk that a credit downgrade will impact the overall fund.
  3. The participants in the market are large professional institutions that have their reputations riding on the ability to keep NAV above $1. With only the very rare case of a fund breaking the buck, no firm wants to be singled out for this type of loss. If this were to happen, it would be devastating to the overall firm and shake the confidence of all its investors, even the ones that weren't impacted. Firms will do just about anything to avoid breaking the buck, and that adds to the safety for investors.

Readying Yourself for the Risks

Although the risks are generally very low, events can put pressure on a money market fund. For example, there can be sudden shifts in interest rates, major credit quality downgrades for multiple firms and/or increased redemptions that weren't anticipated.

Another potential issue could occur if the fed funds rate drops below the expense ratio of the fund, which may produce a loss to the fund's investors.

To reduce the risks and better protect themselves, investors should consider the following:

  • Review what the fund is holding. If you don't understand what you are getting into, then look for another fund.
  • Keep in mind that return is tied to risk—the highest return will typically be the riskiest. One way to increase return without increasing risk is to look for funds with lower fees. The lower fee will allow for a potentially higher return without additional risk.
  • Major firms are typically better funded and will be able to withstand short-term volatility better than smaller firms. In some cases, fund companies will cover losses in a fund to make sure that it doesn't break the buck. All things being equal, larger is safer.

Confusion in the Money Market

Money market funds are sometimes called "money funds" or "money market mutual funds," but should not be confused with the similar-sounding money market deposit accounts offered by banks in the United States.

The major difference is that money market funds are assets held by a brokerage, or possibly a bank, whereas money market deposit accounts are liabilities for a bank, which can invest the money at its discretion—and potentially in (riskier) investments other than money market securities.

If a bank can invest the funds at higher rates than it pays on the money market deposit account, it makes a profit. Money market deposit accounts offered by banks are FDIC insured, so they are safer than money market funds. They often provide a higher yield than a passbook savings account and can be competitive with money market funds, but may have limited transactions or minimum balance requirements.

The Bottom Line

Prior to the 2008 financial crisis, only a couple of small institution funds broke the buck in the preceding 37 years. During the 2008 financial crisis, the U.S. government stepped in and offered to insure any money market fund, giving rise to the expectation that it would do so again if another such calamity were to occur.

It's easy to conclude then that money market funds are very safe and a good option for an investor that wants a higher return than a bank account can provide, and an easy place to allocate cash awaiting future investment with a high level of liquidity. Although it's extremely unlikely that your money market fund will break the buck, it's a possibility that shouldn't be dismissed when the right conditions arise.

Why Money Market Funds Break The Buck (2024)

FAQs

Why Money Market Funds Break The Buck? ›

Breaking the buck may happen when the money market fund's investment income does not cover operating expenses or investment losses. This normally occurs when interest rates drop to very low levels, or the fund uses leverage to create capital risk in otherwise risk-free instruments.

What are the problems with money market funds? ›

Money market investing can be advantageous if you need a relatively safe place to park cash in the short term or if you're diversifying a growth portfolio. Some disadvantages are low returns, a loss of purchasing power, and the lack of FDIC insurance.

Why am I losing money in my money market account? ›

Most financial institutions limit the number of withdrawals that you can make each month. If you exceed the allowed number of withdrawals, a penalty fee will be charged. If you are charged these types of fees then you will lose more money that the interest gained on the account can make up for.

Are money market funds safe in a recession? ›

Money market funds can protect your assets during a recession, but only as a temporary fix and not for long-term growth. In times of economic uncertainty, money market funds offer liquidity for cash reserves that can help you build your portfolio.

Why are money markets paying so much? ›

Money market accounts can offer higher interest rates because they're permitted to invest in certificates of deposit (CDs), government securities, and commercial paper, which savings accounts cannot do. The interest rates on money market accounts are variable, so they rise or fall with inflation.

How do money market funds break the buck? ›

Breaking the buck may happen when the money market fund's investment income does not cover operating expenses or investment losses. This normally occurs when interest rates drop to very low levels, or the fund uses leverage to create capital risk in otherwise risk-free instruments.

When have money market funds broke the buck? ›

On Sept. 16, 2008, the Reserve Primary Fund broke the buck when its net asset value (NAV) fell to $0.97 cents per share. It was one of the first times in the history of investing that a retail money market fund had failed to maintain a $1 per share NAV. The implications sent shockwaves through the industry.

Has anyone lost money in a money market fund? ›

However, this only happens very rarely, but because money market funds are not FDIC-insured, meaning that money market funds can lose money.

What's the catch with a money market account? ›

Money market accounts tend to pay you higher interest rates than other types of savings accounts. On the other hand, money market accounts usually limit the number of transactions you can make by check, debit card, or electronic transfer.

What are 3 cons of a money market account? ›

Disadvantages of money market accounts
  • Limited transactions. Some accounts limit certain transfers and withdrawals (known as convenient transactions) to six per month, so this isn't the best account for regular banking. ...
  • Deposit and balance requirements. ...
  • Fees. ...
  • High interest rates. ...
  • Flexible access. ...
  • Federal insurance.
Mar 18, 2024

What are two disadvantages of a money market fund? ›

Cons of Money Market Funds
  • Your Money Could Earn More Elsewhere. High-risk investments could provide better returns in the long run. ...
  • Your Funds Are Uninsured. If you open a CD or a checking, savings or money market account from a bank, your funds are FDIC-insured. ...
  • You Can Expect Fees.
Nov 14, 2023

Should I worry about money market funds? ›

How safe are money market funds? There is little risk associated with money market funds. The U.S. Securities and Exchange Commission (SEC) mandates that only the highest-credit-rated securities are available in money market funds.

Should I move my money to a money market fund? ›

A money market fund generates income (taxable or tax-free, depending on its portfolio), but little capital appreciation. Money market funds should be used as a place to park money temporarily before investing elsewhere or making an anticipated cash outlay; they are not suitable as long-term investments.

What is the biggest disadvantage of money market? ›

Cons of money market accounts
  1. Depending on your bank, there could be withdrawal limits. Many banks have withdrawal limits on how much you can withdraw from your money market account and how often. ...
  2. Many accounts have monthly fees. ...
  3. Your account might have a minimum balance requirement.

Should I keep all my money in a money market account? ›

But generally, yes, it is worth having. Money market accounts offer a low-risk environment with a higher interest rate to grow your money. Money market accounts are insured by the FDIC and can help individuals reach their short-term savings goals.

Are money market funds smart right now? ›

Right now, investors can earn a competitive yield with low risk. "With short-term interest rates above 5%, money market funds have again become a meaningful part of the investment landscape," says James Dowd, CEO at North Capital.

What is the downside of a money market account? ›

Many accounts have monthly fees

Another drawback to remember is that while they have high yields, money market accounts can also come with cumbersome fees. Many banks and credit unions will impose monthly fees just for the upkeep of your account.

Are money market funds a good idea now? ›

Money market funds can be a good fit for investors looking to benefit from the current interest rate environment or saving for a short-term goal. Keep in mind that while the funds are considered low risk, they are not FDIC-insured.

Are money market funds safe during inflation? ›

So while money market accounts are safe investments, they really don't safeguard you from inflation.

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