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The Federal Reserve's surprise decision Wednesday to slash the federal funds rate half a percentage point to 1.25% had an equally surprising effect on money market funds -- many will be forced to slash fees to avoid breaking the buck.

Money market funds aren't federally insured the way traditional savings accounts or certificates of deposit are, but the fund companies that offer them use strong language assuring investors that the value of one share will always be $1. While the net asset value, or NAV, of virtually all money market funds is kept to $1, the interest yield changes daily as managers buy and sell the short-term securities that make up these funds. If short-term rates are moving higher, money market fund yields also go higher. Typically, the fund's fees are taken out of the yield.

When rates drop -- as they have been for two years -- yields also decrease. When the yield on money funds is less than the expense fees charged by the fund, investors theoretically risk losing principal to those fees -- hence, "breaking the buck." This really is theoretical, though, since in the history of retail money market funds, no fund company has allowed this to happen.

And that's why we can expect a rash of companies to lower or eliminate fees on their money funds.

"It's highly unlikely that fund companies would dip into the money market principal to pay their expenses," says Jeff Tjornehoj, a research analyst at Lipper, a Reuters company. "Investors would be horrified. Mutual fund companies will let those funds be loss leaders to keep investor money in the family."

Average expense ratio for money market funds is 90 basis points, or 0.09%. That doesn't include the 12-b-1 "marketing" fee that two-thirds of all money market funds assess; the average 12-b-1 fee charged is 51 basis points, or .051%. As of Oct. 31, the average yield on money market funds is 0.99%, and more than a few funds have zero yield, according to Lipper. With yields at a fraction of a percent, expenses can easily force a money fund's NAV below $1 -- and that's a "first" that no fund company wants to claim.

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"The first thing many fund companies will do is take a hard look at how much they want that 12-b-1 fee," Tjornehoj says. "Then they'll consider lowering or waiving the expense ratio."

Another Look at That Gift Horse

Don't expect much fanfare among fund companies as they clamor to proclaim fee cuts, though. And don't expect any cuts to be permanent.

"As long as these funds

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a yield, why advertise how they got it?" Tjornehoj points out. "I'm sure they'd prefer people think they're cleverly choosing securities rather than eating fees."

Also, the fee structure on these funds is fairly fungible. Money funds could simply waive fees internally for a few months, and resuscitate them when they anticipate interest rates rising.

Insurance at a Price

Money funds in annuity accounts generally don't feel the same pressure retail funds do to keep from breaking the buck. Indeed, more than 200 money market subaccounts in annuities have lost money year-to-date because their fees


been cut, according to Morningstar data. (The money lost has been miniscule -- roughly 0.5%.)

Annuities are essentially mutual funds with a thin layer of insurance wrapped around them. That thin layer of insurance is used to warrant some pretty fat fees, though. The average money market annuity charged a whopping 1.83% average fee, according to Morningstar. Little wonder they're breaking the buck.

But investors are accustomed to paying higher fees for annuities, and may not be as likely to complain or even notice as retail investors. It can be tougher to tell when a money market annuity breaks the buck, since there's no effort to keep net asset value to $1, the way retail funds do. Because money market subaccounts in annuities don't pay out interest income in the form of distributions (as retail money funds do), the NAV is often a very odd number -- for instance, $9.83. (In other words, one share equals $9.83, as opposed to retail money funds, where one share equals $1.)

This floating NAV, combined with the fact that fees that are generally assessed annually, can make it difficult to determine when investors gave up their principal to pay expenses. And the penalties that often apply keep investors from moving their money.

There's never been a reason to pay high fees for a money market account -- your best bet is almost always the cheapest product, since yields don't typically vary enough to warrant out-of-the-ordinary fees. And if you're happy with your money market fund, there's probably no reason to change. But if you're moving money anyway, there's even more incentive to keep a sharp eye on fees -- after all, not all surprises are happy ones.