Tuesday, October 18, 2011

BREAKING THE BUCK: Are mutual funds safe?

Safe introImage by *spo0ky* via Flickr
           Anyone who reads this blog knows I concentrate on investing for income:  yet every once in a while I opine on other areas of investing.  Today, my focus is pooled investments.  Pooled investments could mean you and your brother in law buy a rental property.  You share your investment with your partner and you share the work.  At least you have 50 percent of the input.   Perhaps it does not
work out so well but at least you have only 50 percent of the blame.   If it works out well you get 50% of the gain and if it does not you get 100 % loss on your investment.  With that in mind, let’s think about this business of pooling your money.

           Most often, we invest our pooled money in a mutual fund, an ETF, or maybe a REIT.  Do you know that money market funds are pooled funds whose charge is to keep your $1.00 investment equal to a dollar?  After all, the theory is that money market funds are just about as safe as cash.

           But, do you know that money market funds are just pooled investments that try to earn a little more income on the money you give them than they pay out?    Money market funds are charged with two responsibilities, keep your $1.00 equal to $1.00 and give you a little income to boot.

           Money market funds are just like bond funds on a shorter-term basis.  Money markets lend your money for more than they pay you. Some entity pays them 1.00 percent and the fund pays your .50 percent.    In this way, they are just like a bond fund except the maturities of their loans are very short.


           How do money market funds stay in business? How do they pay you income? How do they pay their staff?  Money markets earn the difference between what they earn and what they pay you and the fees charged to you.  Fees are very low; therefore, money market funds have to make their living off of the difference between the income they earn on your money and the amount they pay you in interest.

           When I started this article, I researched this idea and my searches came up with articles dated in 2007.  The year 2007 is the year when a prominent money market fund “broke the buck.”  In order to make just a little more than the fund paid out, they invested in Lehman Brother’s debt which proved to be not so secure.  How similar is this to this year when money market funds, have your money invested in European debt?  Look, Europe pays more because it is more risky.

           Folks, be careful of every pooled investment, even if it claims to be as good as cash.  Keep your cash in your safe or your mattress or use certificates of deposit to keep your cash safe.  In this age of such low interest rates, you need to keep your CD’s also in short term maturities.  You never know when inflation will rear and you can get CD’s at 1 percent or 2 percent or maybe even 20 percent like we got in the 1980’s.

Very Truly Yours,
Enhanced by Zemanta