Sept. 24 (Bloomberg) -- Here's a question for investors who hold their cash in the big retail money-market mutual funds: Will you refuse to keep your money there unless it signs up for the new government insurance plan? Or do you trust it bare?

The U.S. Treasury plans to present details this week on a program to maintain confidence in money funds. It will insure you against loss, provided that your fund joins the plan and pays the premiums.

Most of the large money funds that cater to individuals already insure you against loss, using their own resources. Now they'll have to decide whether they want to pay for a layer of government protection, too. If they do, they could either absorb that extra cost or pass it along to investors in the form of slightly reduced returns.

Money funds are designed to act like bank accounts. When you put $1 in you expect to get $1 out, including all the interest earned, any time you want.

Faith in this promise vanished last Tuesday, when the Primary Fund -- owned by the Reserve, the company that invented money-market funds -- closed at 97 cents a share. In industry parlance, it ``broke the buck.''

The Primary Fund got stuck with $785 million in worthless paper issued by bankrupt Lehman Brothers Holdings Inc. Suspecting trouble, its institutional investors started to run.

``A small position in Lehman became a large position as assets left the fund,'' says Peter Rizzo, director of fund services at Standard & Poor's. Two smaller Reserve funds also went down. It's the first time that retail investors have ever had to take a loss.

Shock, Panic

The shock from Reserve set off a panic. Putnam Investments suffered a run on its $12.3 billion institutional Prime Money Market Fund (minimum investment $10 million), forcing it to close. More than $298 billion flowed out of retail and institutional prime funds last week, says Connie Bugbee, managing editor of iMoneynet.com.

Prime money-market funds are the principal buyers of short- term corporate commercial paper, used by corporations to fund their day-to-day operations. To prevent that vital source of money from drying up, the Treasury hastily announced a one-year, $50 billion backup plan. If a taxable or tax-free fund breaks the buck and has to liquidate, the government would guarantee that all its investors -- retail and institutional -- won't lose money. You'll receive your full $1 a share.

A counterproposal from Democratic Senator Chris Dodd would limit the protection to $100,000. That's no help for the big investors that the market needs.

Toxic Paper

Provided that the Dodd limitation doesn't pass, the institutional money funds will probably buy into the plan. They're the most vulnerable, because their customers each control huge amounts of money and are quick to pull the trigger. One of the problems at the Primary Fund was that its customers were predominantly institutional.

Individual investors have small accounts and are slower to move, which gives retail funds more flexibility. Furthermore, the fund sponsors have been insuring their customers themselves.

It may surprise you to hear that, over the past 13 months, 20 money funds might have broken the buck, due to their holdings of paper that turned toxic. They include Ameriprise Financial Inc.'s RiverSource Cash Management Fund, Wachovia Corp.'s Evergreen Money Market Fund and Bank of America Corp.'s Columbia Cash Reserves.

Deep Pockets

What saved these funds is that they're sponsored by large, diversified financial services companies, says Peter Crane, publisher of Money Fund Intelligence, which covers the industry. The sponsors bought the bad paper out of their funds, making investors whole. Maintaining their money funds at $1 a share isn't optional. If they don't, they could lose their entire business, as is the risk for Reserve today.

Then there are the conservative funds such as Vanguard Group. Its Prime Money Market Fund is more than half invested in government securities, one-third in certificates of deposit and only 14 percent in commercial paper. Do Vanguard investors need government insurance to feel safe?

Putnam's retail money funds are operating normally, with no holdings in companies known to be struggling. Two T. Rowe Price Group Inc. funds sold Lehman securities at a discount but didn't break the buck. Fidelity has some exposure to Merrill Lynch & Co. and two subsidiaries of the failed insurance holding company, American International Group Inc., but expects them to pay. Check your fund's Web site. More funds are disclosing their holdings and vowing to support their value at $1 a share.

Wanting Out

The Reserve Fund group isn't a diversified company. Almost all of its business lies in managing money-market funds and it lacked the deep pockets needed to cover the bad Lehman paper, Crane says. All 23 of its funds are now closed to new business and redemptions are being delayed. The Primary fund opened last week with $62.2 billion in assets. By the weekend, $60 billion wanted out.

Some critics worry that the existence of insurance will lead money funds to take more risks. That's not likely, says Andrew Donohue, director of the investment management division at the Securities and Exchange Commission. The insurance clicks in only if a fund fails and is being liquidated -- not anything that any manager would aspire to.

The takeaway for investors is to own retail funds connected with large, profitable and diversified institutions. Where your money flows, over the next couple of weeks, will tell the funds whether, for marketing reasons, they have to be insured.

(Jane Bryant Quinn, a leading personal finance writer and author of ``Smart and Simple Financial Strategies for Busy People,'' is a Bloomberg News columnist. She is a director of Bloomberg LP, parent of Bloomberg News. The opinions expressed are her own.)

To contact the writer of this column: Jane Bryant Quinn in New York at jbquinn@bloomberg.net

Last Updated: September 24, 2008 00:05 EDT