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To the hordes of astute investors who have been plowing their savings into money market funds: congratulations.
For those considering further contributions to money market funds: things are expected to get worse in the broader markets they may not but you'll sleep like a baby at night.
Money market funds provide a nearly risk-free way to hold money in troubled times like these, and can be cashed in quickly if a good opportunity arises. Over the past 20 years, the average Canadian money market fund has returned 4.8 per cent annually. Over the past five years in a lower interest rate environment they have returned 2.4 per cent annually.
Of the over 100 Canadian and U.S. money market fund available on the market 5-year returns are between 1.2 per cent and 3.5 per cent.
A money market fund is a type of mutual fund that holds short-term debt such as guaranteed investment certificates (GICs), treasury bills (T-bills) and other government or corporate securities maturing in a short period of time usually three years or less. Returns are historically low but money market funds are arguably the safest way to protect your principle short of a regular bank savings account. Even a savings account or shoving cash in a mattress won't alleviate the risk of having it nibbled away by inflation.
In normal times, money market funds carry very little direct market risk but these are not normal times. They've been attracting a lot of attention lately in the midst of the credit crisis.
Some U.S. based money market funds hold the type of short-term debt that has been labeled "toxic." Last week, the U.S. Treasury announced it would guarantee all money market funds to prevent a flood of withdrawals.
Toxic debt has not been traced to any Canadian money market funds. The closest we've come to a U.S. subprime crisis is through asset backed commercial paper. ABCP has been traced to at least one Canadian financial institution but crisis was averted when a handful of companies bought back the troubled paper and guarantees were imposed for small investors.
The safety of a money market fund depends on who backs the holdings and it's important to look at what's inside before making a purchase. If the fund consists of government T-bills and GICs the government will stand behind it. There's virtually no chance first-world government debt will fail because governments have unlimited access to capital through the power of taxation.
Corporations, on the other hand, don't have the power of the law to take money from the average Joe and can only attract revenue from willing investors, creditors and consumers. If they can't, they fail.
However, the U.S. government has shown us that it will back corporate debt through its $700-billion bailout package.
If security is what you want perhaps a money market fund that holds only government debt is more to your liking.
Canadian retail investors get additional backing on their investments through the Canadian Investor Protection Fund, which insures up to one million dollars "for losses of securities, commodity and futures contracts, segregated insurance funds and cash" in an investment account.
Coverage does not apply to market losses and the fund will only cover losses if a member investment dealer is insolvent. For coverage details and a list of member financials institutions visit the Fund's website at www.cipf.ca.
Retail investments are also insured up to $100,000 by the Canadian Deposit Insurance Corporation if a member fails or goes bankrupt.
Like the CIPF, CDIC coverage has conditions. Details can be found at www.cdic.ca.
Dale Jackson has been a producer at Report on Business Television since its launch in September 1999.