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Super-Safe Saving

Jan 2007

Saving your money in a safe place may seem like an obvious priority. Why would anyone want to put savings somewhere unsafe? But the fact remains that a large percentage of popular saving and investing vehicles provide no guarantee of earnings, nor even assurance that the original capital will be preserved. Those that do make such a guarantee are considered ultra secure, but the price of low risk is, invariably, low returns. "There's a time and place in every household where surplus cash needs to be preserved for a while, like for buying a car, or building a down payment for a house, or just keeping emergency money accessible," said Bill Ellis of Seattle Northwest Securities Corp. "That's when you need low-risk, low-yield securities like T-bills, U.S. government agency securities, or commercial paper."

U.S. securities are most secure
A T-bill, or Treasury bill, is a short-term security issued by the U.S. Treasury, typically at a minimum of $1,000 for periods ranging from 3 to 12 months. T-bills initially are issued at a discount, and the investor receives the full value - also known as "par value" - at the end of the agreed term. A 12-month T-bill, for example, could cost $9,375. At the end of a year, the investor might receive $10,000, with the $625 difference reflecting interest earnings.

U.S. government agency securities are securities issued by the U.S. government other than T-bills, notes, and bonds. Examples of such securities are issued by the Federal National Mortgage Association (called Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), the Small Business Administration, and the Student Loan Marketing Association (Sallie Mae). Commercial paper is a short-term, promissory note issued by corporations for terms ranging from 1 to 270 days. The worth of commercial paper can differ considerably from corporation to corporation.

A money market mutual fund can combine them all
One can purchase a package of all the above securities in the form of a money market mutual fund (MMMF). There are many kinds of mutual funds, but all operate as large pools of cash managed by an investment company. A fund manager is a specialist assigned to use the cash to purchase specific types of investments. Very few mutual funds are low risk, and the types of investments accumulated within the mutual fund are determined by the degree of risk investors are willing to bear. MMMFs, designed as much to preserve the capital investment as they are to yield income, are comparatively low risk. A typical MMMF will include any combination of high-quality, short-term securities like T-Bills, commercial paper, or certificates of deposit.

"Money market mutual funds are not for retirement planning or saving to put kids through college, because there are far better returns to be earned elsewhere over the long term," said Ellis. "But they are useful for short-term savings needs or just to buy time while you figure out an investment strategy for the long haul."

MMMFs let you move money quickly and flexibly while keeping risk exposure low. Ironically, MMMFs are not federally insured but are nevertheless considered secure because they contain a portfolio of quality investments with short-term average maturities. What's more, management fees are typically less than 1 percent of average net assets. MMMFs are available in both taxable and nontaxable form. Nontaxable MMMFs invest in debt issued by states and their political subdivisions, such as cities, counties, and special districts that are exempt from federal income tax.

In theory it is possible for the market value of an MMMF to fall below $1 a share, a rare event known as "breaking the buck." It almost happened in the late 80s and again in the mid-90s, but on both occasions the values were made whole by the issuers of the commercial paper (which was defaulting), and by the MMMF sponsors themselves.

Proceed with caution
When shopping for an MMMF beware of those boasting a quarter of one percentage point more than the comparable competition, because they're likely to hold a portfolio that includes some derivatives. Derivatives are complex financial instruments - such as structured notes, inverse floaters, and collateralized mortgage obligations - and are to be avoided here.

- Audrey Arkins, contributor

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