What is Breaking the Buck
Breaking the buck occurs when the net asset value (NAV) of a money market fund falls below $1. Breaking the buck can happen when the money market fund's investment income does not cover operating expenses or investment losses. This normally occurs when interest rates drop to very low levels, or the fund has used leverage to create capital risk in otherwise risk-free instruments.
BREAKING DOWN Breaking the Buck
Breaking the buck can signal economic distress because money market funds are considered to be nearly risk-free. Investors often use money market funds in addition to checkable deposit accounts as an additional source of liquid savings. These funds are a type of open-end mutual fund that invests in short-term debt securities such as U.S. Treasury bills and commercial paper. They offer a higher return than standard-interest checking and savings accounts. They are not insured by the Federal Deposit Insurance Corp. (FDIC).
The NAV of a money market fund normally stays constant at $1. This is facilitated by market regulations. Market regulations allow a fund to value its investments at amortized cost rather than market value. This gives the fund a constant $1 value and helps investors identify it as an alternative to checking and savings accounts. By using an amortized pricing structure, the fund can manage the activities of the fund and provide for redemptions. (See also: Why Money Market Funds Break the Buck.)
Most money market funds have check-writing capabilities and also allow money to be easily transferred from a money market fund to a bank account. Money market funds pay regular interest that can be reinvested in the fund.
Money Market Fund History
Money market funds were first introduced in the 1970s. Their use helped to make investors more aware of the benefits of mutual funds, which helped significantly increase asset flows and increase demand for mutual funds. The first money market mutual fund was named the Reserve Fund and established the standard $1 NAV.
The first case of a money market fund breaking the buck occurred in 1994, when Community Bankers U.S. Government Money Market Fund was liquidated at 94 cents because of large losses in derivatives.
In 2008 the Reserve Fund was affected by the bankruptcy of Lehman Brothers and subsequent financial crisis. The Reserve Fund’s price fell below $1 due to assets held with Lehman Brothers. Investors fled the fund and caused panic for money market mutual funds in general. (See also: Money Market Mayhem: The Reserve Fund Meltdown.)
Following the 2008 financial crisis, the government responded with new Rule 2a-7 legislation supporting money market funds. Rule 2a-7 instituted numerous provisions. Money market funds now cannot have an average dollar-weighted portfolio maturity exceeding 60 days. They also now have limitations on asset investments. (See also: A Safer Money Market with Rule 2a-7.)
Money Market Fund Investing
Vanguard is a leader in money market fund products. It offers three taxable money market funds and numerous tax-exempt funds all priced at $1. Its best-performing money market fund is the Vanguard Prime Money Market Fund. It had a one-year return of 0.97 percent through Nov. 30, 2017.
For more on money market funds see also: Money Market Mutual Funds: A Better Savings Account, Do Money-Market Funds Pay? and Breaking The Buck: Why Low Risk Is Not Risk-Free.