How Safe Are the Money Funds?

IF You have put cash in a money market fund, not only are your savings collecting relatively high interest, but most probably they are also quite safe. Certainly, money funds have most of the convenient attributes of bank checking accounts. Almost always, you can take out, dollar for dollar, what you have put in, plus dividends. They are usually declared daily and automatically credited to your account once a month.

However, there are some risks. Although investors look upon money market funds as reliable alternatives to the friendly neighborhood bank, even the soundest of them are a bit chancier than banks. For one thing, money fund interest rates can plummet. Back in 1976, for example, they even dropped below passbook savings rates.

Also, guardian angels do not watch over every money market fund. In 1978, a small fund, the First Multifund for Daily Income, had to lower its share price from $1 to 93 cents. That was like a bank coldly telling its depositors: "Sorry, but we will now return only 93 cents of every dollar in your account." Redemptions began accelerating, and First Multifund eventually merged into another fund. In 1980, another fund, Institutional Liquid Assets, came close to a similar experience. But then its distinguished sponsors, which included the First National Bank of Chicago and the Wall Street investment banking firm of Salomon Brothers, pumped in new money and so, investors could collect 100 cents on the dollar.

The lesson for investors is not to abandon money funds but to choose them with care. Here are three guidelines:

First, know the manager or sponsor. You needn't entrust your money to complete strangers. You may already do business with a firm that sponsors a money fund, say, a brokerage house, a life insurance company or a mutual fund group. A sponsor with an established reputation for financial responsibility will not jeopardize it by abandoning its customers. Strong sponsorship can give investors more peace of mind.

Second, go for funds whose securities have a low average maturity. The temptation of money fund managers is to extend their maturities and lock in high returns when they think interest rates are about to fall. These days, however, a Securities and Exchange Commission rule compels most funds to stay within an upper limit of 60 days. By going longer, the funds risk having to report sharp cuts in daily dividends if they guess wrong and rates rise higher. That could cause their shareholders to switch to higher paying funds. Nevertheless, favor a fund that doesn't stray far from the pack. When other funds are hovering around the 35 day mark, be wary of those with average maturities in the 40s or 50s.

Third and to repeat don't chase after the highest possible yields, or the hottest fund of the month, Over a year's time, the difference in interest payments between one fund and another is likely to be inconsequential. The customer shouldn't be greedy. He or she should expect a reasonable rate of return.

You can look up the rating of your money market fund in a newsletter called Income & Safety. It ranks the 135 largest funds from AAA+ through BB on the basis of the diversification, maturity and quality of their investments.