NEW YORK -- If you keep your ready savings in a bank money-market deposit account, you are sacrificing yield. You could earn perhaps 1.2 percentage points more by switching to a money-market mutual fund.
And now, there's more reason than ever to consider it. Both the Securities and Exchange Commission and the industry's trade group, the Investment Company Institute, are backing new money-fund safety regulations. In a reverse of the usual story, the trade group wants even tougher rules than those the government is proposing.
A money-market mutual fund invests your savings in short-term instruments, including government securities, bank certificates of deposit and commercial paper (which are short-term loans to corporations).
The funds pay variable market interest rates (generally about 8 percent today), and undertake to maintain the value of your investment at a steady $1 a share.
By contrast, the money-market deposit accounts offered by banking institutions don't pay a true market interest rate. Instead, they pay whatever rate best suits the banks. But deposit accounts are safe. No matter what happens to the bank, you're insured by federal deposit insurance for up to $100,000.
The same cannot be said for money-market mutual funds. No one has ever lost a dime in a true money fund, but you could. In fact, over the past year perhaps a dozen of the funds might have reported losses had they not been bailed out by their sponsors.
The Achilles heel for taxable money funds is commercial paper -- those short-term loans to corporations. Under current SEC rules, the funds are allowed to invest in both top-grade and second-grade paper. Over the past year, two issuers of second-grade paper (ranked A2 by Standard & Poor's and P2 by Moody's) have gone into default.
To reduce the money-fund loss,the SEC proposes to limit how much second-grade commercial paper funds can hold. It suggests a maximum of 5 percent of assets, with no more than 1 percent in the paper of any one issuer.
The trade group would go even further. It wants money funds to hold no second-grade paper at all.
In my opinion, money funds are safe enough for conservative investors, as long as they buy only top-grade commercial paper (rated A1 or P1), top-rated bank certificates of deposit and government securities (check the prospectus to see what they buy, or ask the fund what its policy is). Super-conservative funds invest only in government securities and still pay more than you'd get from most bank money-market deposit accounts.
The Achilles heel of tax-exempt money-market funds are the bank letters of credit that guarantee the safety and liquidity of certain municipal securities, especially those issued by housing or community-development authorities. If for any reason the bank was called upon to pay, and couldn't, the municipal fund would face a loss.
For this reason, James Lynch and Christine Carter Lynch of the Lynch Municipal Bond Advisory newsletter in Santa Fe, N.M., have suggested that conservative investors switch into money funds invested in government securities.
Mary Novick, a vice president at Standard & Poor's Ratings Group, strongly disagrees with the Lynches. S&P rates a number of money funds Triple-A, based both on the soundness of the issuer and of the bank. The Vanguard Group's Ian MacKinnon points out that if the bank develops financial problems, the municipality would simply get a letter of credit from another bank. If this worries you, however, stick with municipal funds rated Triple-A by S&P.