Are All Money Markets Created Equal, or Are Some Implicitly Safer Than Others?

In these trying economic times, all investors are concerned about the safety of their nest eggs. Money markets are generally regarded as safe investments - but do they all perform equally in a major market meltdown?

Given the current turbulence in the stock market and the worldwide economic recession, people need a safe place for their savings now more than ever. Earning a little interest doesn't hurt either. Ever since the inception of money market mutual funds in 1971, investors have been using them as a secure place to stash their cash. Traditionally, money market accounts earn slightly better interest rates than regular savings accounts, and often offer more flexibility, like check writing privileges. However, are money markets really as safe as they are purported to be?

Money Market Mutual Funds vs. Money Market Deposit Accounts: What's the Difference?

The term "money market" can be quite confusing, due to the fact that it is used to describe two different types of investments that have dissimilar risk profiles. A money market deposit account is almost exactly the same thing as a savings account - typically, the only difference is that you can write checks from a money market deposit account. These accounts are FDIC insured and are therefore just as safe as any savings account . Money market mutual fund accounts, however, are mutual funds - meaning that the money in them is being invested in securities. Money market mutual funds are required by law to invest in low-risk securities, such as commercial paper, CDs and government securities, but that doesn't mean they are risk free. Investors should consider these differences before choosing which type of money market account they prefer.

Money Market Mutual Funds: How They Work

Money market mutual funds don't actually pay interest - they pay dividends, which are then expressed as a percent yield. The investment objective of money market mutual funds is to ensure that the share price and/or net asset value (NAV) remains constant at $1. The yield will vary based on how well the underlying investments perform. As long as the NAV remains $1, investors will not lose money - the yield may become very small, but shares can still be sold for the same price ($1) at which they were purchased. However, if the NAV goes below $1 (also known as "breaking the buck"), investors wishing to sell their shares would be forced to sell for less than $1 and would therefore lose money. To date, only two money market mutual funds have ever broken the buck, the most recent being the Reserve Primary Fund on Sept. 16, 2008.

What is the Safest Money Market Mutual Fund?

All money market mutual funds have the same investment objective and are subject to the same rules and regulations; so on paper, all money market mutual funds should be equally safe. However, the events of Sept. 16, 2008 proved that this is definitely not the case. The Reserve Primary Fund broke the buck because many of its investments were in Lehman Brothers' debt, and when Lehman went bankrupt , those investments became worthless. While the average investor had no way of knowing that was going to happen, taking a look at the securities that make up your money market mutual fund's investments to make sure there aren't any that look too risky isn't a bad idea. Also, choosing a money market mutual fund from a large, well-established company like Vanguard, Fidelity or T. Rowe Price may be a smart move, because companies like this should be able to make up the difference with other assets if the investments in their money market mutual funds go south.

How Does Safety Affect Money Market Mutual Fund Returns?

As with all investments, greater risk in a money market mutual fund carries the possibility of greater rewards . Funds with higher yields than their competitors are likely invested in riskier securities. Although the likelihood of a money market mutual fund failure is slim, it can happen. Investors who are particularly risk averse may want to seek out money market mutual funds that invest only in government securities, since these are widely regarded to be the most stable investments available. However, such investors will have to be content with slightly lower yields.

How Should You Choose a Money Market Mutual Fund?

Many investors select their money market mutual fund based on convenience, choosing the money market mutual fund offered by their regular brokerage or mutual fund company. Others seek out the money market mutual fund with the highest returns . Choosing a money market mutual fund based on yield alone is fine, but investors must always remember that higher returns mean higher risk, even with seemingly "safe" investments like money market mutual funds.