How are the words "money market" like the word "dolphin?" Answer: both are labels that represent two completely different things. Whether you're a fisherman or an investor, you need to know the difference.
Here’s a reader email I recently received about the safety of money market accounts. But it offers an opportunity to learn all kinds of stuff, from money market accounts to the Greek debt crisis to the difference between two sea creatures. Check it out…
I read your article about Greek debt with both interest and concern. I had just finished reading an article “How the Greek Debt Crisis Could Slam US Savers” by Jon Markman. I can understand how a Greek default would affect the economy of other countries. It’s a little more difficult for me to understand how a Greek default would affect money market accounts. Do you think this is a real concern and what should a retired senior do to protect their nest egg? If money market accounts are vulnerable to loss (and I know money market accounts slipped below $1 a share a couple of year ago) then seemingly no investment would be safe.
I would greatly appreciate your thoughts on this before I pull my retirement money out of money markets and bury it in the back yard.
Here’s your answer, Frank!
The first thing I did, of course, was read Mr. Markman’s article, which paints a picture of global economic Armageddon. From his article:
In a nutshell, European banks own piles of souring Greek credit, and U.S. banks own piles of European bank credit, which means Americans’ financial instruments ranging from the mundane to the speculative – including both your money market fund and your international bond funds – can be at risk, and perilously so.
To be fair, Mr. Markman does offer some potential hope. Much as I suggested in my article, he agrees that Europe will likely bail out Greece and thus save the world. I encourage you to read his article, my article, and others so you can understand the risk floating around out there. But the question remains: How safe are money market funds?
Are you serving Flipper?
I used to own a restaurant – other than my first wife, the stupidest financial decision I’ve ever made. But I digress.
At my restaurant, we sold dolphin sandwiches. Multiple times every day, patrons would ask, “Is this Flipper?” The answer, of course, was no. As it happens, there are two completely different creatures living in the ocean that share the same name. “Flipper” is a bottle-nosed dolphin. They’re mammals that you’ll find at Sea World, but (hopefully) never on a menu. The other dolphin, shortened from “dolphinfish” and often called by its Hawaiian name, Mahi-Mahi, is a popular menu item. Two creatures + one name = dining confusion.
Two types of money markets
The term “money market” is often used interchangeably for two investments that are as different as Flipper and Mahi-Mahi. One is a bank account, the other a mutual fund. The big difference? Bank accounts are insured up to $250,000 by Uncle Sam. Mutual funds aren’t.
Frank is asking about the mutual fund type of money market account. How do I know? Because he says, “I know money market accounts slipped below $1 a share a couple of year ago,” which only applies to mutual funds. Bank money markets are basically savings accounts – unlike the mutual fund variety, they don’t have a share value.
Both types of money market accounts are routinely used as safe harbors for short-term funds, both are considered secure places to park money, and both offer lousy interest rates as a result. But if the poop really hits the fan, bank money markets are infinitely safer by virtue of their FDIC insurance.
So why would anyone choose a mutual fund money market over the insured bank kind? Two reasons.
First, while not insured, they’re pretty darn safe. Very few money market mutual funds have ever traded below their standard $1/share value. When that threatened to occur back in 2008 at the height of the financial crisis, the Department of the Treasury stepped in and offered FDIC-like insurance to prevent a run on this multi-trillion dollar industry. (You can read about that program’s inception in this 2008 New York Times article and its conclusion in this 2009 USA Today article.)
The second reason investors like Frank often choose money market mutual funds over the bank variety better explains their popularity: They typically pay higher interest. The key word in that sentence, however, was “typically.” Many of today’s money market mutual funds are actually paying less than bank money market funds – a historical anomaly.
Go to our rates page and you’ll see that you can easily find a bank money market account (MMA) that pays 1 percent. The return on money market mutual funds these days is often as low .01 percent – virtually nothing.
You don’t have to be a Wall Street wizard to see that investing in a money market mutual fund makes no sense whatsoever, because not only are bank money market accounts insured, they pay 100 times more interest.
I owe Frank an apology for turning a short question into a long story, but I wanted to take the opportunity for a little schooling for others. Now that we’ve done that, here’s the bottom line: Frank, I doubt the Greek debt crisis will sink your money market mutual fund. But since there’s a safer place to put your money that pays 100 times more interest, there’s something fishy about sticking with one. Maybe it’s time for you, me, and millions of other investors in money market mutual funds to become “flippers.”