Broke the Buck

Broke the Buck is a phrase that strikes fear into the heart of the cash management world. It describes the rare but seismic event where a money market fund (MMF) is unable to maintain its stable Net Asset Value (NAV) of $1.00 per share (or €1.00 in Europe) and its value falls below this level. Money market funds are a type of mutual fund designed to be an ultrasafe place for investors to park cash. They invest in high-quality, short-term debt instruments like commercial paper, certificates of deposit, and U.S. Treasury bills. Their entire appeal rests on the promise of preserving capital and maintaining that stable $1.00 share price, acting as a cash equivalent. When a fund “breaks the buck,” it means investors who redeem their shares will get back less money than they put in. This shatters the perception of absolute safety and can trigger widespread panic, as it did during the 2008 Financial Crisis.

For decades, investors have treated money market funds as if they were as safe as a bank savings account. This perception is powerful, but it's crucial to understand it's an industry convention, not a guarantee. Unlike a bank deposit, which is typically insured by a government agency like the FDIC in the United States, money market funds have no such backstop. So, how do they maintain that stable $1.00 value?

• High-Quality, Short-Term Assets: They invest in debt that matures very quickly (usually under 90 days), which minimizes exposure to interest rate fluctuations and credit risk.
• Special Accounting: Funds often use amortized cost accounting, which allows them to value their holdings at their purchase price plus any accrued interest, rather than at their fluctuating market price. This smooths out the tiny daily price movements of the underlying bonds.

This system works exceptionally well almost all the time. The fund's managers maintain a small cushion, so even if some of their assets dip slightly in value, the overall NAV per share remains pegged at $1.00. Breaking the buck only happens when a sudden, large loss overwhelms this cushion.

The most notorious example of a fund breaking the buck occurred in September 2008. The Reserve Primary Fund, one of the oldest MMFs in the U.S., held a significant amount of commercial paper issued by the investment bank Lehman Brothers. When Lehman declared bankruptcy, that paper became virtually worthless overnight. This sudden loss was too large for the fund to absorb. On September 16, 2008, its NAV fell to $0.97 per share. It had broken the buck. The news sent shockwaves through the financial system. If the “safest” type of fund could lose money, what was truly safe? Investors panicked and pulled hundreds of billions of dollars out of MMFs in a matter of days, creating a “run” on the entire industry. This threatened to freeze the short-term lending markets that companies rely on for daily operations. The U.S. government was forced to step in and temporarily guarantee money market fund assets to restore confidence and stop the run.

The concept of breaking the buck, while rare, offers timeless lessons for the prudent value investor. It cuts to the core of understanding risk and the true nature of an investment.

• Lesson 1: Understand What You Own. This is the first rule of investing. A money market fund is not cash in a bank. It is a portfolio of short-term debt securities. While it's designed to mimic cash, it carries a different, albeit small, risk profile. Knowing this distinction is fundamental to proper asset allocation and risk management.
• Lesson 2: Risk is Not Volatility. Value investors focus on avoiding the permanent loss of capital, not just temporary price swings (volatility). Breaking the buck is the perfect example of permanent loss. The investors in the Reserve Primary Fund didn't just see their shares dip; they received less cash back than they invested. The goal is not just to find undervalued assets, but to build a portfolio that is resilient to these kinds of catastrophic, capital-destroying events.
• Lesson 3: Differentiate Your “Cash” Holdings. For an emergency fund or very short-term operational cash, nothing beats the safety of a government-insured bank deposit. For slightly higher yield on a cash-like holding, MMFs are a reasonable tool, especially those that invest solely in government bonds. The 2008 crisis serves as a stark reminder that during periods of extreme systemic stress, correlations go to one—meaning everything can fall at once—and the only true safe havens are those explicitly backed by a government.