FatCamera / iStock.com
A common financial instrument that causes a lot of confusion for some investors is a money market fund. Many think that these financial instruments are the same as the money market accounts of similar sound, which are very similar to savings accounts.
However, money market funds, sometimes called money market mutual funds, are open-ended mutual funds that invest in short-term securities. Investment professionals often design them to preserve money. Although money market funds have a modest risk, they can produce higher returns while offering more security and liquidity than other fixed income investment vehicles.
These funds will not make you rich, but they can meet the needs of certain money-focused investments.
What is a money market fund and how does it work?
Money market fund managers invest in short-term, low-risk debt securities, which are typically characterized by low volatility. These funds seek to trade at a net asset value of $ 1 per share, distributing the income to investors in the form of a dividend.
Although money market funds tend to pay lower interest rates than some other fixed-income investment vehicles, the compensation is their security and stability. Investors who need to save money for emergencies – or simply want to store money while waiting for their next capital investments – often choose money market funds.
However, it is important to note that, unlike other options, such as savings accounts, money invested in a money market fund is not protected by FDIC insurance.
When funds fall below the $ 1 per share benchmark, it’s called “breaking the money”. This does not happen often, but it did happen in September 2008 after Lehman Brothers filed for bankruptcy. The crisis has pushed some money market funds down to 97 cents a share. When this happened, the government intervened and secured all stable value funds.
Despite this bailout, money market mutual funds typically do not benefit from insurance guarantees or government intervention.
So what is a money market fund for? They are a relatively safe way to invest and are generally more stable and affordable than other investment options.
Types of money market mutual funds
What is a background example of the money market? Various financial instruments can constitute a money market mutual fund. The most common are:
Retail funds limit ownership to individual investors.
As the name suggests, institutional money market funds serve institutions more than individuals. Unlike most money markets, the NAV here can float depending on market conditions. Businesses and pension funds often buy these types of mutual funds.
Government money market funds invest a minimum of 99.5% of their funds in government securities. This usually means U.S. Treasury bonds, but it could also mean government-sponsored companies like Fannie Mae and Freddie Mac.
Both retail and institutional investors can buy this type of money market funds.
Prime funds, sometimes called “general purpose” funds, invest in short-term bank and corporate debt.
Municipal money markets invest their assets in tax-exempt bonds issued by municipalities. These funds receive federal income tax exemptions and, in some cases, state personal income tax exemptions.
Here’s a look at the different types of money market mutual funds:
|Background type||Primary types of instruments owned|
|Retail funds||Designed for individual investors; works to maintain the net asset value of $ 1 per share|
|Institutional Funds||It serves institutions such as companies and pension funds; may have a floating NAV|
|Farm||At least 99.5% invested in U.S. Treasury cash and bonds, with at least 80% invested in Treasury bonds|
|Treasury only||At least 99.5% invested in cash, U.S. Treasury bonds and / or repurchase agreements, with at least 80% invested in Treasury bonds and repurchase agreements|
|Government||At least 99.5% invested in cash, U.S. Treasury bonds and / or repurchase agreements, with at least 80% invested in Treasury bonds and repurchase agreements; this may also include government-sponsored companies such as Fannie Mae and Freddie Mac, but the U.S. Treasury neither issues nor guarantees those securities.|
|Main funds (general purpose).||Assets invested in any approved money market instrument denominated in US dollars, as defined by the SEC; this includes commercial paper, certificates of deposit, corporate promissory notes, private instruments of foreign or domestic issuers, and reverse repurchase agreements.|
|Municipal National||Invest at least 80% of the fund’s assets in municipal securities where interest is exempt from federal income tax|
|Municipal State||It invests at least 80% of the fund’s assets in municipal securities where interest is exempt from federal income tax and personal state income taxes.|
Who could consider investing in a money market fund?
Most people and institutions that use money market funds have one thing in mind: the preservation of capital. But in most cases, account holders can have immediate access to their funds.
In addition, money markets tend to offer higher interest rates than standard savings accounts. And while money market funds do not benefit from FDIC insurance, they have a high degree of security, as they invest in high-quality, ultra-short-term securities.
Considerations when investing in a money market fund
Although money market funds offer certain benefits that you cannot get with other financial instruments, these funds do not necessarily suit all fixed income investments. For this reason, people and institutions should consider the following:
Reasons for spending
Expense ratios are the annual costs of owning a fund, and are deducted from the revenue the fund generates. Especially in a money market fund, where capital appreciation is not an option, a low spending ratio is critical.
Even the safest funds must manage exposure and risk. Although money market funds can generally maintain a stable $ 1 NAV, some funds may have riskier assets than others.
One concern in recent years has been negative interest rates. Funds need positive rates to generate the money needed to cover their rates and the yields of payments to money market fund investors. However, with the Fed embarking on a cycle of aggressive interest rate hikes, it is now less of an issue, but it remains to be seen.
Money Market Funds Vs. money market accounts
While a money market fund is a mutual fund, a money market account works like a bank account.
Like savings accounts, money market accounts generally limit withdrawals to six a month, although they have been temporarily suspended due to COVID-19, and are protected by the FDIC. In this way, they function more as savings accounts than as investment funds.
How to buy money market funds
Buying a money market fund is similar to buying a stock. You can simply sign in to your brokerage account and purchase the fund of your choice.
If you want help choosing the right money market fund, some online brokerages offer tips for a fee. Otherwise, you can find a trusted financial advisor.
Are money market funds right for you?
Is a money market fund a good investment? Money market funds work best for those who need instant access to a lot of money. These funds will not make you rich, but they will provide a relatively safe place to store funds and get a modest return, often higher than what a savings account offers.
John Csiszar contributed to this article.
Our in-house research team and on-site financial experts work together to create accurate, unbiased, and up-to-date content. We check all statistics, citations, and facts using trusted primary resources to make sure the information we provide is correct. You can learn more about GOBankingRates processes and standards in our editorial policy.