The past year has been a year of dashed illusions. We can now cite as faulty the notions that real estate always increases in value, that the smart guys running the investment banks know what they’re doing, and that money market mutual funds are risk-free.

That last one came crashing down last September, when the Reserve Primary Fund became only the second player in the 37-year history of money market funds to “break the buck.” The net asset value of its shares slipped from the $1 that the funds strive to maintain to 97 cents. The decline occurred after the fund wrote off bad debt from Lehman Brothers Holdings Inc., which had just filed for bankruptcy.

Money market funds generally had been viewed as investments that, at a minimum, would preserve an investor’s principal. The sudden possibility of losses triggered a run on money market funds. Investors, especially institutional investors, withdrew about $210 billion over two days. At that point, Treasury stepped in to stop the outflow by guaranteeing that investors would receive $1 for each share they held in participating money market funds as of Sept. 19, 2008.

The guarantee has been extended until Sept. 18 of this year. By then, the industry says, it can safely expire, in large part because many funds will have adopted ways to make themselves more secure and more liquid, meaning their assets can easily be converted to cash.

The proposed new safeguards were developed by the Money Market Working Group created by the Investment Company Institute, the trade association for mutual funds. Although some of the recommendations call for action by the Securities and Exchange Commission, members of the working group have agreed to implement guidelines that don’t require SEC action by Sept. 18.

Companies represented on the working group, which is headed by John J. Brennan, chairman of the Vanguard Group, include Black Rock, Legg Mason, JPMorgan Asset Management, Goldman Sachs, Invesco, Federated, Charles Schwab, Fidelity Investments and Western Asset Management—in other words, major players.

Although other notions have been advanced to make money market mutual funds more secure, the working group has some interesting ideas. But before we get into that, just a quick reminder of the differences between money market mutual funds and money market accounts. Often individual investors confuse the two, but money market accounts are insured by the Federal Deposit Insurance Corp., while money market mutual funds are not.

“Consumers should understand that these funds are not as safe as bank accounts. They are not covered by FDIC insurance, and they are not a promise to pay back a certain amount,” said Tamar Frankel of the Boston University School of Law, an expert on financial system regulation. “In a bank, the promise is to pay back the dollar even if the assets of the bank may be less. In a money market fund, investors get the dollar they put in, plus or minus whatever is in the box.”

Nonetheless, because they invest conservatively and emphasize liquidity, money market funds have been viewed as a safe, if low-return, place to put your money. With the exception of a couple of days last September, they have attracted investors fleeing riskier stock market investments. After Treasury intervened, that flow continued until total investments reached a high of just under $3.9 trillion at the end of January.

Vanguard’s Brennan, in an interview about the working group’s recommendations posted on the Vanguard website, said that many of them are not new practices but represent best practices already in place at many funds. The group said they should become required minimum standards for the industry.

Here are some of the major recommendations:

Extend liquidity. Although SEC rules governing money market funds bar them from investing more than 10 percent of their assets in illiquid securities, the SEC doesn’t have explicit requirements for how liquid the funds have had to be over all. The report recommends having 5 percent of a fund’s net assets in securities that could be cashed in within a day, and 20 percent in securities that would be accessible within seven days. The group also recommended making money market funds’ holdings even more short-term, reducing the weighted average maturity of fund portfolios from 90 days to 75 days.

Know the client base. The report said that during last fall’s run by investors, “Some money market funds were surprised by particularly severe redemption pressures because they may have lacked detailed knowledge of their client base.” To minimize that risk, it recommended that the funds “know their clients.” In other words, if most shares are in the hands of a very few large clients, and they want their money back, a fund could be in trouble. The working group also recommended that funds provide that information on their websites on a monthly basis.

Examine securities for risk. Also, the group proposed that funds no longer be allowed to invest in certain types of lower-rated short-term securities, and that funds create committees to examine what risks might exist in complicated new types of securities, which “may in hindsight appear too complex or otherwise imprudent for a money market fund.”

These are all steps that, if implemented, should make money market funds even safer. Of course, more safety often comes at the price of lower returns. But Brennan, in the Vanguard interview, said he didn’t think that would necessarily be the case. “For those funds where the recommendations require a meaningful change in portfolio composition, they may result in lower yield. For other funds, where there is less change required, they may have a minimal effect on yield.”

Either way, investors who never dreamed how risky these funds could be may be willing to pay the price for safety.

Something Good

In reaction to concerns that reduced withholding for pensioners might cause some retirees to owe extra taxes, the IRS has just released adjusted withholding procedures for pensions. The problem, pointed out by the Pension Rights Center (see “Your Financial Future: Potential Pension Glitch”), was that pensioners who don’t work would not be eligible for the Making Work Pay tax credit, which is supposed to reduce taxes by the same amount as withholding is reduced. As a result, if a pensioner’s withholding was reduced by $300, she would owe an additional $400 at tax time and would need to come up with the money.

Martha M. Hamilton writes regularly for AARP Bulletin Today. A future column will be on what people are doing with their extra $250 Social Security payment. Please e-mail her at martha1hamilton@yahoo.com and let her know what you are doing with yours.