Can You Lose Money in a Money Market Fund?
Explore the safety of money market funds. Understand the rare conditions under which principal loss is possible, despite strong regulatory oversight.
Money market funds (MMFs) are often viewed as highly stable and liquid investment options, frequently serving as an alternative to traditional bank savings accounts. This perception of safety stems from their investment strategy, which focuses on short-term, low-risk debt securities. While generally considered secure, the possibility of losing principal in a money market fund warrants closer examination.
What Are Money Market Funds?
Money market funds are a type of mutual fund that primarily invests in highly liquid, short-term debt instruments. These instruments include commercial paper, Treasury bills, and certificates of deposit, all characterized by brief maturities and minimal credit risk. The main objectives of MMFs are capital preservation, maintaining liquidity, and generating modest income for investors.
MMFs aim to maintain a stable Net Asset Value (NAV), typically $1.00 per share. They generate income through interest earned on their underlying securities, which is then distributed to shareholders as dividends. There are different categories of MMFs, including government funds, prime funds, and tax-exempt (municipal) funds, distinguished by the types of debt securities they hold.
Scenarios Leading to Principal Loss
While rare, it is possible to lose principal in a money market fund, an event known as “breaking the buck.” This occurs when a fund’s Net Asset Value (NAV) falls below the standard $1.00 per share. Such an event happens when the value of the fund’s underlying investments declines due to credit risk, meaning an issuer of the securities held by the fund defaults on its obligations.
A notable instance of a money market fund breaking the buck occurred in September 2008 with the Reserve Primary Fund. This fund, which had significant holdings in commercial paper issued by Lehman Brothers, saw its NAV fall to $0.97 per share following Lehman’s bankruptcy. The default of Lehman Brothers rendered a portion of the fund’s assets worthless, triggering a wave of redemption requests the fund could not meet at its stable NAV. This event highlighted the potential for principal loss, especially in prime funds that invest in corporate debt, which carries more credit risk than government funds.
Regulatory Framework and Investor Protections
The Securities and Exchange Commission (SEC) regulates money market funds through Rule 2a-7 of the Investment Company Act of 1940. This rule imposes strict requirements on MMFs to mitigate risk, including mandates for diversification, high credit quality of investments, and specific liquidity levels. MMFs must hold at least 25% of their total assets in daily liquid assets and 50% in weekly liquid assets to ensure they can meet redemption demands.
Money market funds are not insured by the Federal Deposit Insurance Corporation (FDIC), unlike traditional bank accounts. While regulations aim to minimize risk, there is no direct government guarantee against principal loss. Regulatory reforms implemented in 2014 and further amended in 2023 introduced additional safeguards. These reforms included requirements for institutional prime and municipal money market funds to operate with a floating NAV, and for certain funds to impose liquidity fees during periods of heavy redemptions to discourage rapid withdrawals. Redemption gates, which allowed funds to temporarily suspend redemptions, have largely been removed from the regulatory framework.