If you have read newspaper or watched TV, you probably heard that a big money market fund “broke the buck” last week. That means it was not able to maintain the stable $1 Net Asset Value (NAV). Investors in that fund lost 3% when the NAV dropped to $0.97. Another money market fund run by Putnam decided to shutdown and return the money to the investors because it didn’t want to sell its assets in a difficult market. Later the federal government said they would guarantee the money market funds.
As the title of this post reads, I say breaking the buck isn’t a big deal. Why? Because it happens all the time. You just don’t know it because it isn’t obvious. This is called money illusion. The before-tax, before-inflation value isn’t that meaningful. You can’t spend before-tax, before-inflation money. You can only spend after-tax, after-inflation money. When you factor in tax and inflation, money market funds lose money all the time.
Here are the returns of Vanguard Prime Money Market Fund, one of the best money market funds in the U.S. At a marginal tax rate of only 15%, the fund’s after-tax, after-inflation return was negative four years in a row from 2002 to 2005. It’s also negative so far in 2008. If the tax rate is higher, it gets worse. If you are interested in seeing the numbers for a different tax rate, you can use the online spreadsheet I created.
So if you are already losing money in a money market fund, what’s the big deal of losing a little bit more?
Looking at a different angle, even if a money market fund breaks the buck before tax before inflation, you will see that the fund actually performed a lot better this year than other mutual funds. Again, using Vanguard data through Sept. 19, 2008, including the big rebound on Sept. 18 and Sept. 19, the 2008 year-to-date returns are:
|Vanguard Prime Money Market Fund||+2.05%|
|Vanguard Total Bond Market Index Fund||+1.42%|
|Vanguard 500 Index Fund||-13.23%|
|Vanguard Total Stock Market Index Fund||-11.82%|
|Vanguard Total International Stock Index Fund||-23.03%|
|Vanguard Emerging Markets Stock Index Fund||-29.86%|
My thoughts on the risks in money market funds didn’t change from what I wrote last year. Worrying about a money market fund losing 1%, 2% or 3% while other funds have lost 15%, 20%, or 30% is really focusing on the wrong problem.