Money Market Fund: A Smart Investment Move?

Money market funds are a type of mutual fund that invests in highly-rated, short-term debt securities. They generate income but little to no capital appreciation. Money market funds are considered low-risk, low-return investments. They are ideal for short-term financial goals, such as saving for a vacation, a wedding, or a down payment on a house. Money market funds are also useful for maintaining an emergency fund or covering larger regular expenses. While they offer better yields than standard bank savings accounts, money market funds are not suitable for long-term investment goals due to their low returns and lack of capital appreciation.

What are money market funds?

Money market funds are a type of mutual fund that invests in highly-rated, short-term debt securities. They generate income but little (if any) capital appreciation. Money market funds were established in the 1970s to provide a slightly higher-yielding alternative to interest-bearing bank accounts.

Money market funds invest in highly liquid, near-term instruments, such as cash-equivalent securities and high-credit-rating, debt-based securities with short-term maturities (e.g. US Treasury Bills). They are intended to offer investors high liquidity with a very low level of risk.

Money market funds are also called money market mutual funds and are insured by the Securities Investor Protection Corporation (SIPC). However, they are not covered by the Federal Deposit Insurance Corporation's (FDIC) federal deposit insurance.

Money market funds are considered extremely low-risk and are a safe avenue for investing in secure and highly liquid, cash-equivalent, debt-based assets using smaller investment amounts. They are characterised as low-risk, low-return investments and are therefore not suitable for long-term investment goals like retirement planning.

Money market funds can be used as a place to park money temporarily before investing elsewhere or making an anticipated cash outlay. They are also useful for short-term saving and immediate- to short-term savings goals that you don't want to be impacted by market volatility.

Are money market funds a good investment?

Money market funds are a type of mutual fund that invests in highly liquid, short-term debt instruments and cash equivalents. They are intended as a short-term, liquid investment, providing little capital appreciation but generating modest income through interest.

Money market funds are considered a safe investment option, with a target value of $1 per share. They have only dipped below this value ("broken the buck") on a small number of occasions, usually associated with financial crises, and have quickly bounced back. However, they are not appropriate for long-term investing goals, such as retirement investing, as they don't offer much capital appreciation and their returns have not kept pace with inflation.

Money market funds are also not insured by the Federal Deposit Insurance Corporation (FDIC). This means that, unlike money market accounts (MMAs), the principal value of money market funds can fluctuate, and investors could lose money.

Money market funds can be a good option for those with short-term financial goals, such as saving for a vacation, a wedding, or a down payment on a house. They are also useful for maintaining an emergency fund or parking assets while deciding how to invest them for the long term.

Overall, money market funds can be a good investment option for those looking for a stable, secure, and liquid investment in the short term. However, they may not be suitable for those seeking long-term capital growth or those who want their investments to be FDIC-insured.

How do money market funds work?

Money market funds are a type of mutual fund that invests in highly-rated, short-term debt securities. They are designed to offer a safe, stable investment option for money that may be needed in the short term. Money market funds are not the same as money market accounts.

Money market funds work like a typical mutual fund. They issue redeemable units or shares to investors and are mandated to follow the guidelines drafted by financial regulators. Money market funds invest in low-risk assets like Treasury bonds, certificates of deposit (CDs), or short-term, high-quality corporate bonds with maturities of less than a year.

The funds blend highly-rated, short-term securities with longer-dated securities (up to 397 days for most funds). Some money market funds seek to offer a constant net asset value (NAV) of 1.00 in the respective currency, while other types of funds float their NAV to the fourth decimal place. While yield is not a primary objective, funds seek to offer investors the potential for income that approximates the rate on other overnight or short-term investments.

Money market funds are required by the respective regional regulations to maintain sufficient liquidity to meet reasonably foreseeable redemptions. Generally, they must invest at least 10% of their portfolios in assets that can provide daily liquidity, and at least 30% of their portfolios in assets that can provide weekly liquidity, although there are exceptions.

Money market mutual fund investors receive dividend income that reflects current short-term interest rates and is redeemable on demand. In addition, a retail money market fund is managed to keep the fund’s net asset value (NAV)—the per-share value of its assets minus its liabilities—stable at $1 per share.

Types of money market funds

Money market funds are typically divided into three categories: government, prime, and municipal.

Government funds invest in cash, US Treasury securities, and repurchase agreements that are collateralized by US Treasury securities. They are considered to be one of the least volatile types of investment available.

Prime funds, also known as general-purpose funds, invest in government securities as well as commercial paper, certificates of deposit, and short-term securities issued by domestic and foreign corporations. They also invest in repurchase and reverse repurchase agreements. Prime funds are considered retail money funds and are only available to natural persons.

Municipal or tax-exempt funds invest the majority of their assets in securities that are exempt from federal income tax. They are considered retail money funds and are only available to natural persons. Municipal money market funds are particularly appealing for those in high-income tax brackets.

Money market funds are classified into various types depending on the class of invested assets, the maturity period, and other attributes. For example, a prime money fund invests in floating-rate debt and commercial paper of non-Treasury assets, while a government money fund invests at least 99.5% of its total assets in cash, government securities, and repurchase agreements that are fully collateralized by cash or government securities.

Money market funds vs. money market accounts

Money market funds and money market accounts are two different financial products with distinct features. Here is a detailed comparison between the two:

Money Market Funds

Money market funds are a type of mutual fund that invests in highly-rated, short-term debt securities. They were established in the 1970s to provide a slightly higher-yielding alternative to interest-bearing bank accounts. Money market funds typically invest in low-risk vehicles such as certificates of deposit (CDs), Treasury bills (T-bills), and short-term commercial paper.

Advantages of Money Market Funds

• Low Risk and Short Duration: Money market funds are considered less risky than stocks and bonds due to their focus on low-risk, short-term investments. This makes them attractive during volatile market conditions.
• Stability and Security: Money market funds are one of the least volatile investment options available, helping to offset the greater volatility of stocks and bonds in a portfolio.
• Potential Tax Efficiency: Some interest payments from money market fund investments may be exempt from federal and state income taxes.

Disadvantages of Money Market Funds

• Low Returns: Money market funds typically generate low single-digit returns, which may not keep up with inflation over time.
• Loss of Purchasing Power: If the inflation rate exceeds the fund's return, investors lose purchasing power.
• Expenses: Annual fees can eat into profits, especially when returns are low.
• No Federal Insurance Protection: Money market funds are not insured by the FDIC, although the Securities Investor Protection Corporation (SIPC) provides some financial protection.

Money Market Accounts

Money market accounts, also known as money market deposit accounts, are federally insured liquid bank accounts that pay interest on deposits. They combine features of both checking and savings accounts.

Advantages of Money Market Accounts

• Interest: Money market accounts offer higher interest rates than traditional savings accounts, sometimes exceeding 5% APY.
• Liquidity: These accounts provide easy access to funds, often through features like ATM cards, debit cards, or check-writing privileges.
• Federal Insurance: Money market accounts are insured by the FDIC or NCUA, providing coverage of up to $250,000 per depositor.

Disadvantages of Money Market Accounts

• Transaction Limits: Money market accounts usually have restrictions on the number of withdrawals or transfers per month, typically limited to six.
• Fees: These accounts may have higher minimum balance requirements and tend to charge higher fees than checking or savings accounts.

Key Differences

The main differences between money market funds and money market accounts lie in their risk level, liquidity, and insurance protection:

• Money market funds are considered low-risk but are not federally insured, while money market accounts are insured by the FDIC or NCUA.
• Money market funds may offer slightly higher returns but have less liquidity due to the absence of features like debit cards or check-writing.
• Money market accounts are opened at banks or credit unions, while money market funds are opened at brokerages and are better suited for long-term savings goals.

In summary, money market funds offer a relatively safe, low-return option for short-term financial goals, while money market accounts provide higher interest rates, liquidity, and federal insurance protection, making them ideal for emergency funds and short-term savings.

Frequently asked questions