Investors with a focus on the preservation of capital often seek out fixed-income solutions such as government or low-risk municipal bonds, preferred stocks, traditional bank savings products, or money market mutual funds. Each of these investment vehicles provides a degree of safety from otherwise volatile securities markets in addition to a potential stream of fixed income. Although each strategy has its own merits and drawbacks, a money market fund is a popular choice among risk-averse investors. Read on to find out more about this kind of investment and how you can benefit from these putting your money into this product.
Key Takeaways
- Money market funds invest in highly liquid securities like cash, cash equivalents, and high-rated debt-based securities.
- These funds offer investors liquidity because they're invested in securities with short-term maturities—usually 13 months or less.
- Because they only invest in highly rated securities, money market funds offer a high degree of safety.
- Money market funds also offer investors higher yields than traditional savings accounts.
What Is a Money Market Fund?
A money market fund is a type of mutual fund. It invests in highly liquid vehicles such as cash, cash equivalents, and high-rated debt-based securities. These securities tend to have short-term maturities—usually less than 13 months. Many money market funds hold securities like commercial paper and U.S. Treasury bills.
Investors purchase units or shares of a money market fund from a mutual fund company or through a broker. Just like other mutual funds, there may be a minimum initial investment amount required to take part in a money market fund. They also come with an expense ratio. This fee is calculated as a total percentage of the fund's asset which covers its administrative and operating expenses.
Don't confuse money market funds with money market accounts (MMAs). Although they may sound alike, they are different. A money market account is a savings account offered by traditional financial institutions, allowing the account holder to earn interest on the average balance. Because they are intended to act as a savings vehicle, MMAs allow investors limited withdrawals. These accounts are insuredby theFederal Deposit Insurance Corporation(FDIC), while money market funds are not.
Types of Money Market Funds
Money market funds are divided into different categories depending on their attributes including their maturities and the classes of securities. For instance, government money market funds invest the majority of their assets in cash and government securities. Treasury funds invest in U.S. Treasury bills, bonds, and notes. Another type of money market fund is the tax-exempt fund. These types of funds invest primarily in vehicles that are exempt from federal taxes such as municipal bonds.
Benefits of Money Market Funds
A money market fund provides investors with an array of benefits that you may not find with other investments. The most common are noted below.
Liquidity
Money market mutual funds provide investors with liquidity. That's because these funds are invested in securities that mature in short periods of time and can be liquidated for cash. Fund managers invest pooled investor dollars into money market securities including bank certificates of deposit (CDs), federal agency notes, high-grade commercial paper, or government treasury issues such as T-bills.
Safety
Investors who want to park their money in a relatively safe investment may want to consider money market funds. The Securities and Exchange Commission (SEC) mandates that only securities with the highest credit ratings are available to purchase in money market funds, creating a degree of safety for investors not found in other fixed-income investments. This also helps set them apart from other investments such as stocks which are characterized by a higher degree of volatility.
Higher Yields
In addition to safety and liquidity, money market funds offer the potential for higher yields than conventional cash equivalents such as savings or money market accounts from a bank or credit union. The objective of a money market fund it to keep its net asset value (NAV) steadily at $1, resulting in no growth of principal. Despite this, money market funds provide investors slightly higher yields than conventional cash equivalents over time because fund managers can diversify the underlying investments.
Although they're considered relatively safe investments, money market funds also come with inherent risks including inflation, credit, and interest rate risks.
A Word on Risks
Even though they're considered a primarily safe place to put your cash, money market funds do come with their own inherent risks—just like any other investment. A few things investors may want to consider are:
- Inflation Risk: This risk occurs when the cash flows from a money market fund drop because of inflation. In other words, inflation cuts down how the money market fund performs.
- Credit Risk: Because they aren't insured by the FDIC like savings accounts and CDs, there's no guarantee that you won't lose your money.
- Interest Rate Risk: This is the risk associated with fluctuating interest rates. Yields share an inverse relationship with interest rates, so when interest rates rise, yields drop and vice versa.
FAQs
Money market funds are a type of mutual fund that may provide higher income potential than a bank savings account and more flexibility than certificates of deposit (CDs). If you have an investment goal, you likely know when you're going to need the money and how long you'll need it to last.
Why should I invest in a money market fund? ›
Money market funds are a type of mutual fund that may provide higher income potential than a bank savings account and more flexibility than certificates of deposit (CDs). If you have an investment goal, you likely know when you're going to need the money and how long you'll need it to last.
What are the pros and cons of the money market? ›
Money market accounts are savings accounts that often offer higher interest rates than regular savings accounts and often incorporate checking account features, like easy access to cash. Yet they can also have downsides: Many have minimum balance requirements and excessive fees.
What are the risks of investing in a money market fund? ›
You could lose money by investing in a money market fund. An investment in a money market fund is not a bank account and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.
How profitable is a money market fund? ›
Higher Returns Than Traditional Savings Accounts
While your savings account might be giving you returns that can't even buy you a pack of unga, Money Market Funds often offer much more competitive rates. It's like upgrading from a kibanda to a fancy restaurant! The current KCB MMF rate as of July 2024 is 15.50%!
How much money should you keep in a money market account? ›
Some money market accounts require minimum account balances for the higher rate of interest. Six to 12 months of living expenses are typically recommended for the amount of money that should be kept in cash in these types of accounts as emergency funds. Beyond that, not investing will mean missing potential earnings.
Do you pay taxes on money market accounts? ›
The earnings from money market funds can come from interest income or capital gains, so they're taxed the same way as other investment income.
How much will $10,000 make in a money market account? ›
How much will $10,000 make in a money market account in one year? The amount you earn from depositing $10,000 in a money market account over one year depends on the APY offered by your bank. With daily compounding and monthly interest payments, you would earn approximately $64 at the industry average rate of 0.64% APY.
How long should I keep money in a money market fund? ›
Money market funds are usually considered to be safe investments, but it's important to remember that these investments are intended for the short term. With maturities of 13 months or less, the funds stay liquid and allow you better access to your money than longer-term investments.
What are the problems with money market funds? ›
There are two main types of liquidity risks faced by money market funds: funding liquidity risk (if the fund's liquidity is insufficient to meet redemptions) and market liquidity risk (if market volatility forces funds to sell securities below the mark-to-market price in order to meet large redemptions or maintain ...
Our picks at a glance
| Fund | Yield | Minimum investment |
|---|
| Vanguard Cash Reserves Federal Money Market Fund Admiral Shares (VMRXX) | 5.3% | $3,000 |
| Vanguard Treasury Money Market Fund (VUSXX) | 5.29% | $3,000 |
| PIMCO Government Money Market Fund (AMAXX) | 5.12% | $1,000 |
| Schwab Government Money Fund Investor Shares (SNVXX) | 5.03% | $0 |
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But what happens when the Fed starts cutting rates? Yields on money market funds will fall. It's possible the Fed could cut rates rather quickly. Those 5% yields could turn into 2-3% yields in a relatively short period of time if inflation keeps falling, the economy slows even further or some combination of the two.
Are money market funds safe in a crash? ›
Both money market accounts and money market funds are relatively safe, low-risk investments, but MMAs are insured up to $250,000 per depositor by the FDIC and money market funds aren't.
Are money market funds safe in a recession? ›
Money market funds can protect your assets during a recession, but only as a temporary fix and not for long-term growth. In times of economic uncertainty, money market funds offer liquidity for cash reserves that can help you build your portfolio.
Are money market funds a good idea now? ›
Money market funds can be a good fit for investors looking to benefit from the current interest rate environment or saving for a short-term goal. Keep in mind that while the funds are considered low risk, they are not FDIC-insured.
Are money markets FDIC insured? ›
Money market funds, like mutual funds, are neither FDIC insured nor guaranteed by the U.S. government or government agency and are not deposits or obligations of, or guaranteed by, any bank. There can be no assurance that these funds will be able to maintain a stable net asset value of $1 per share.
Why is money market better than savings? ›
Money market accounts may pay a higher interest rate than traditional savings accounts because banks invest in short-term, highly liquid, low-risk assets with the funds. Many money market accounts come with minimum balance requirements.
What is the 7 day yield on a money market fund? ›
What is the 7-day yield? The 7-Day Yield represents the annualized fund yield based on the average income paid out over the previous seven days assuming interest income is not reinvested and it reflects the effect of all applicable waivers.
Why is money market necessary? ›
It helps to strengthen the balance between the demand and supply of short-term monetary transactions in the market. It helps businesses grow, which can positively affect economic development. It assists with the evaluation of certain monetary policies.
