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A word of warning to money market investors

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With the stock market not far from record highs and in the midst of a longer-than-usual period of relative calm, many investors appear to be getting nervous about a potential market correction. And they’re putting long-term investment decisions on hold for now. Many seem equally concerned about the return of their money as well as a return on their money.

That may be why nearly $2.7 trillion is now invested in the 20 largest U.S. money market funds.

I like to tell investors who look to invest excess cash to keep my three rules for doing so in mind.

Rule #1: Always be able to withdraw your money without penalty or restrictions.

Rule #2: Seek the most competitive interest rate.

Rule #3: Never break Rule #1.

If you have a lot of cash building up in a money market fund, it’s time to pay attention. Rules enacted two years ago that affect the funds’ regulation are set to become effective next month.

If you own a money market fund subject to these rules, your fund could restrict your access to withdrawals, charge redemption fees or even allow the fund to fall below the time-honored $1 per share net asset value, which means your shares would be worth less than what you paid for them.

During the financial crisis of 2008 and 2009, several money market funds -- notably the Reserve Primary Fund -- “broke the buck” (by falling below that $1 threshold) and halted investor withdrawals because the funds held some short-term notes whose issuer (Lehman Brothers was a major culprit) filed for bankruptcy. Many investors in these “prime,” or institutional, money market funds were large professional investors as well as individuals. 

Needless to say, it didn’t help investor confidence to hear that a fund failed, leaving investors to lose money and unable to withdraw their cash.

Beginning Oct. 14, some money market funds will be allowed to charge shareholders liquidity fees of up to 2 percent on redemptions. Certain funds can also impose redemption “gates” that would allow them to halt all withdrawals for up to 10 days. 

These fees and restrictions would be applied during periods of “extraordinary financial market stress” and be imposed when a fund’s weekly liquid assets fall below 30 percent of total assets.

These restrictions and fees will apply to specific types of money market funds called prime, general purpose and municipal/tax-exempt. Of course, since these funds invest in higher-yielding paper and are designed for both individual and corporate investors, they often provide slightly higher interest rates.

But certain types of money market funds are exempt from these new restrictions, specifically those that invest solely in U.S. Treasury securities and other securities backed by the U.S. government. So these funds are a safer bet for your cash.

If you have a brokerage account with a money market fund or hold cash in one, call your broker and ask if your fund is subject to the new rules. If it is, move your cash to a U.S. Treasury or government money market fund. Also make sure that the new fund is the core or “sweep” fund, which means the proceeds of all future sales, dividends and interest will be automatically deposited into it.