Investor Alert: Money Market Dangers

When fund managers invest in commercial paper issued by corporations that have no collateral, they can feel pretty secure that a company such as General Electric will make good on paying the money back. But with the asset-backed commercial paper, all too much of it is backed by mortgages...sub-prime ones at that.

So, as sub-prime mortgages go into default and foreclosures hit record numbers, the potential is there for more serious problems. If the money isn't coming in from homeowners, there's no money to pay fund managers. Since the mortgage turmoil really began to show itself a year ago, a slew of short-term bond funds and international money market funds have been beaten up.

Watch out: there is plenty more paper out there where this junk came from. More adjustable rate mortgages (ARMs) are adjusting to higher rates and will have to be refinanced because they were given to homeowners at then below-market rates to facilitate the deals. Now failures are showing up in the higher-tier Alt A mortgages and even prime mortgages.

It is more difficult for many Americans to refinance in order to avoid foreclosure because lenders have adopted tougher credit standards (a little late) for prospective borrowers.

We strongly believe there is more risk on the horizon for investors of all stripes.

What to Do Now

For safety-seeking money market investors, the truth is there is no 100% safety in this challenging environment.

Now for the good news: We feel fairly confident that most mutual fund companies won't leave money market investors hanging in the wind. If their fund does "break a buck," most companies are likely to ride to the rescue and make you whole. But the headlines in the papers could cause you to spend some sleepless nights in the interim.

If you have cash invested in a money market fund, make sure it is one issued by a very large company such as Vanguard or Fidelity. In these tough economic times, you want to be certain there is enough money available to keep the $1-a-share value with a cash infusion if more financial institutions fail. For complete comfort, accept lower yields and switch a Treasury money market fund.

Dolan Straight Talk Tip: In fact, if you currently have cash in a money market fund, we strongly urge you to consider moving it out of there and buying Treasury bills of three- and six-month durations. The yield is next to horrible but still beats the return of your mattress! And most importantly, you'll have the guarantee of Uncle Sam who promises to pay -- even if our government has to print more money to do it!

If you're not used to buying T-bills directly, consider a mutual fund that will do it for you. Although there are a number of good short-term Treasury funds available, here's a good place to start your search: the Vanguard Short-Term Treasury Fund (ticker symbol: VFISX), which seeks to provide current income with limited price volatility. We think it's worth a look. Check it out at the Vanguard web site.

To learn more investing wisely strategies, check out these links:

• How to Choose the Right Money Market Fund
• The Dolans' 10 Simple Rules of Investing
• Getting Started in Stocks