What Is a Money Market Fund? (2024)

When you are looking for a place to invest your extra cash, there are plenty of alternatives, from savings accounts to certificates of deposit.

If you have an investment account, and you’re familiar with mutual funds, money market funds can be a great choice.

These funds, which invest in short-term bonds, offer more flexibility than CDs and interest rates that are often slightly better than what you can find with top savings accounts.

It’s a big reason money market fund assets have jumped to $5.1 trillion in March from $4.3 trillion in 2020, before the Federal Reserve started raising interest rates to fight inflation.

“Money market funds have become a much more interesting place,” says Jay McLaughlin, institutional sales manager for iMoneyNet, a research firm that follows the money market fund industry. “If rates continue to rise—and we’re headed in that direction right now—they present a nice opportunity to make significant gains while equity markets continue to sort themselves out.”

Read on to find out more about how money market funds compare other common savings vehicles and whether they are right for you.

Note: Interest rates in this story are as of March 2023, while rates frequently fluctuate we’ve included them to make it easier for you to compare relative yields offered by different types of investment.

How money market funds work

The first thing for investors to understand is that money market funds are mutual funds, not bank accounts. They take your investment and buy high-quality, short-term debt—such as government Treasury bills, federal agency notes, corporate issues, or municipal bonds, depending on the particular type of fund.

These are among the safest investments available on the market. That is because there is minimal chance of default, and thanks to the short-term nature of the investments, you are not exposing yourself to long-term interest rate risk.

Because of that stable structure, money market funds are able to peg their share price to a dollar. You might encounter the phrase, net asset value, or NAV. It refers to the value of each share of a mutual fund—in other words, the fund’s assets minus its liabilities, divided by the number of shares it has issued. For money market funds, that NAV is always set at $1 per share.

The upshot of this arrangement is that unlike a stock, or a traditional mutual fund, the value of money market fund shares do not appreciate. You buy in and sell out at $1 a share. Still, you can expect your money market investment to grow over time because the funds issue regular dividends. When you research funds you will see the value of these payouts quoted as an annual percentage of your overall investment—your investment yield.

“Typically a money market fund pays dividends monthly, which you can reinvest in the fund or have paid out to you,” says Richard Carter, vice president of fixed income products for money managers Fidelity. “As interest rates move higher…that drives up the rates you can achieve on money market funds.”

To be clear, there is not zero investment danger. As with all mutual funds, there are no guarantees of value, and none of the Federal Deposit Insurance Corp. backing attached to bank accounts.

And since money market funds are essentially investments in portfolios of bonds, there is the potential that extreme credit concerns could cause the underlying holdings to lose value. It is called “breaking the buck,” if a fund falls below that $1 per share value. Historically, though, that happens very rarely—the last time was during the financial crisis of 2008, to the Reserve Primary Fund. Afterward, regulatory authorities put in place more safeguards to ensure that doesn’t happen again.

Types of money market funds

Not all money market funds are created alike. They fall into three main categories, and those different buckets have slight differences when it comes to holdings, risk and yield.

Government money market funds

Government money market funds invest in federal securities such as U.S. Treasurys, as well as agency bonds such as from Fannie Mae or Freddie Mac. One prominent example would be the $13 billion Schwab Government Money Fund (SNVXX), with a 7-day yield of 4.23%.

Prime money market funds

The second is prime money market funds, which can include the aforementioned federal securities, but also a broader mix such as commercial paper (short-term bonds issued by companies). At that point you have stepped away from federal guarantees, so the risk level and yield has typically ticked up. One example is the $7.7 billion Fidelity money market Fund (SPRXX) and its 7-day yield of 4.35%.

Municipal money market funds

Municipal money market funds appeal to many high-income investors because of their tax-exempt nature. Muni bonds can be issued by states, local governments or agencies and their interest is exempt from federal and usually state income tax. One popular muni money market fund is the $17 billion Vanguard Municipal money market Fund (VMSXX) and its current 7-day yield of 2.65%—a yield which on its face is lower than other fund types, but after taxes are considered, can actually be higher for some investors.

As always in investing, the choice between these types of money market funds comes down to personal elements like portfolio makeup, risk tolerance, and the purpose the money is serving. If you are looking for pure safety, you might go the government route; if you are interested in more yield, a prime fund might be right for you; if you are looking for shelter from taxes, a municipal fund is the way to go.

Money-market funds vs. savings accounts

For individual investors, there is a fair amount of confusion here, and for good reason. There are money market funds, and then there are bank savings accounts—and some of those savings products are called money market accounts.

Savings accounts (including money market accounts) are bank products, and so are covered by FDIC insurance. You open them at a banking institution, and not your investment brokerage, which is where you find money market funds. Banks offer a set interest rate, sometimes have investment minimums, and can have restrictions in terms of how often you can access that money (for instance, a certain number of times per month).

Bank savings accounts certainly have their own advantages, such as convenience—if linked to your checking account, for instance, you can seamlessly move money back and forth as needed. The interest offered can vary widely: National averages are so low as to be almost nothing, while high-yield savings accounts—such as those offered by some online banks—can be quite competitive, currently generating interest of 4% or more.

In contrast, money market funds generate yield (as opposed to paying a stated rate of interest), which may fluctuate along with broader market conditions and the specific bonds it owns. There are no federal guarantees of principal, and as mutual funds, they are sold once a day after the market closes (unlike, say, an exchange-traded fund which can be sold at any time throughout the day).

Money-market funds offer their own advantages: Compared to assembling your own short-term bond portfolio, it’s easy one-stop shopping. “If you invest in a bond or CD as a single instrument, you have to think about maturity dates, and the market risk involved in selling,” says Fidelity’s Carter. “Whereas with a money market fund, the money is there at all times.”

And compared to bank savings accounts, the yield can be very attractive indeed—currently averaging 4.25%, according to iMoneyNet—while offering the same kind of liquidity and access.

How to get the best money market fund rates

Typically your stock trading platform may have a default money market fund for its clients, established at your initial sign-up, as a kind of placeholder to keep your cash. But that doesn’t necessarily mean you are locked into that fund.

Depending on the platform or brokerage you use, there may be other options available to you—perhaps a whole lineup of them. Others may be more suitable for you, depending on your risk tolerance, or tax situation, or expectations for yield. “As an investor it’s always worthwhile to shop around, and see if there’s a fund that better fits your needs,” says iMoneyNet’s McLaughlin.

In evaluating funds investors should look at classic metrics like yield, expense ratio—a measure of the fund’s costs—and past performance. You can perform this due diligence at the sites of your brokerage house, or the fund provider, or consumer sites like Yahoo Finance or MarketWatch.

In an area like short-term debt there won’t be a huge differential in total returns, so “one of the largest separators is going to be expense ratio,” says Tim Schiltz, director of product management for Charles Schwab Investment Management. “If you are looking at two funds and one has an expense ratio four basis points higher, you will likely choose the less expensive one, because that will boost your net yield.”

Top money market fund families

Other considerations include the size of the fund, and the fund family. Some investors may find a comfort level by sticking with the larger players in the space, such as Vanguard Group, Schwab, State Street, Fidelity, or Capital Group’s American Funds.

“Is the brand recognizable, how long have they been in the industry, and do they have experience?” asks Schiltz. “You might also look at how big the funds are: Would I rather go into a multibillion-dollar fund, or a $100 million one where it could be disruptive if investors leave the fund?”

Once you have found a money manager and a particular fund that is right for you, then you face the broader personal question of what this money is for, and how much to allocate. While money market funds don’t offer the long-term growth potential of stocks, they are uniquely tailored for shorter-term needs.

“If an investor is expecting to make a big purchase in a two- or three-year time period—whether buying a house, or putting kids through college—this is a great spot to park those assets,” says McLaughlin. “You don’t have to worry about principal being eroded, and you are making 4% to 5% yield right now.”

More about Savings

• Best CD Rates
• How to Build a CD Ladder
• Finally! Savings Rates Could Soon Beat Inflation