Money market funds are a type of mutual fund that relies on specific short-term investments, like cash, commercial debt, and U.S. Treasury notes. They are considered low-risk, and they provide high liquidity. They are not the same as money market accounts.
As soon as you begin researching investment options, you’ll run into an endless stream of terms and products that can quickly become overwhelming. Money market funds are best suited for certain narrow investment uses. Read on to fully understand how money market funds can be used to your advantage.
Money market funds are a type of mutual fund. A mutual fund is aninvestment productthat bundles many different investments. For example, instead of buying a single share in a company, you can purchase fractions of shares in many companies. This makes mutual funds good for diversification and helps insulate your investments should there be changes in the market.
Money market funds are different than most mutual funds, however. Instead of purchasing fractions of common stocks, you’re buying a stake in high-quality, short-term cash and debt securities.
Money market funds definition:
Federally regulated mutual funds that invest in U.S. Treasuries, commercial paper, and other short-term debt securities.
What do money market funds invest in?
They’re invested almost exclusively in types of debt securities with short maturities. All money market fund investments are required by federal regulation to be high quality and to have a weighted average maturity of 60 days or less. There’s little chance of default, and the risks are low. Here are some of the common types of money market funds:
Government (or Treasury) money market funds:These are mostly invested in Treasury notes and bills, but they can include other vehicles, like bonds or repurchase agreements.
Prime money market funds:These hold mostly commercial paper, which can include certificates of deposit (CDs), banker’s notes, and other short-term debt securities. Some think of them as low-risk “IOUs” that trade among financial institutions.
Municipal money market funds:These usually hold tax-advantaged federal or state bonds or securities.
How good are money market fund returns?
The 7-day current yield of money market funds is typically around 1% to 3%. Considering that well-diversified stock portfolios often target 8% to 10% growth (with much higher risk profile, of course), investing primarily in money market funds isn’t always an optimal long-term investment strategy. Money market funds are usually used as a targeted investment strategy with considered goals, like mitigating the risk of a potential bear market or parking extra money is a safe spot while awaiting an investment opportunity. Keep in mind that with such low yields inflation can play a significant role in your returns. If inflation is rising above or is near the yield of your money market fund, it can wipe out most (or even all) of your gains. If inflation is steady, or falling, money market funds may be more attractive.
Are money market funds FDIC insured?
No. Even though the primary investment objective of many money market funds is capital preservation, as with most investments, there is a chance a money market fund can lose value. Money marketaccountsare FDIC insured. See the next point to understand the difference.
How are money market funds different from money market accounts?
Due to the similar names, there is often confusion between these two types of financial products. They are not the same. Money market funds are a type of mutual fund, which is an investment product and has the possibility of losing money. Money market accounts are a type of savings account offered by a bank that is FDIC-insured, so it will not lose value. Because of their added safety, money market accounts often have an even lower projected return than money market funds.
Money market funds are generally used by investors who have a low risk tolerance (like those with enough savings who are already in retirement) or investors who are looking for a temporary place to park money. Because their returns tend to be small, money market funds are generally not a sound long-term retirement savings tool. That said, they can be used as a risk-mitigation tool in a well-diversified portfolio.
Whether or not they are right for you will depend on far too many factors to fully cover in this article. Your best option is to discuss your strategies with a financial services professional. In addition to guidance on money market funds, we have awide selection of mutual fundsyou can invest in.
Do money market funds have fees?
Yes, but they tend to be low, considering the lower yields of money market funds. These fees, as with fees for most mutual funds, are in the form of expense ratios. It’s important to take the cost of mutual funds into account when comparing potential investments.
Pros and cons of money market funds
While money market funds are considered to be extremely low risk investments, they may not be your best option, because the returns are often quite low. Here are some of the other things you should keep in mind:
- Low volatility and low risk
- Better returns than bank accounts
- Short duration provides liquidity
- Potential tax benefits
- Lower returns than with other equity and fixed income mutual funds
- Not FDIC insured
- Returns may not keep up with inflation
- Changes to financial rules and regulations can pose a risk
Are there alternatives to money market funds?
Yes. There are many options that have similar rates of return, and each has different pros and cons. Certificates of deposit (CDs) are FDIC-insured and can have similar returns, but they lack the liquidity of money market funds. With CDs, you’re locked into a time period, and you will usually face penalties for early withdrawal. High-yield savings accounts may give you some of what you’re looking for, but they often have high balance requirements. Money marketaccounts, as we’ve said previously, are similar to savings accounts, but with different rules and benefits. Federal government bonds, as well as mutual funds that deal exclusively in government debt, are backed by the federal government, but they may have rules on how and when you can cash them in and are subject to market volatility. Fixed income investments are also subject to credit and interest rate risk.
Choosing the right investments depends on your risk profile, situation and outlook. If you’re saving for retirement, you’ll first want to get a better understanding of how much you currently have saved versus how much you’ll need. Then, you can begin to build a strong, diversified portfolio to help meet your goals. The good news is that you don’t have to figure everything out for yourself. If you’d like to discuss your plans and develop a custom retirement strategy, afinancial services professionalcan help.
1Diversification does not assure a profit or protect against market loss.
You could lose money by investing in the Fund. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. The Fund may impose a fee upon sale of your shares or temporarily suspend your ability to sell shares if the Fund's liquidity falls below required minimums of market conditions or other factors. An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Fund's sponsor has no legal obligation to provide financial support to the Fund, and you should not expect that the sponsor will provide financial support to the Fund at any time.
I'm a financial expert with a deep understanding of investment products and strategies. I have hands-on experience in the field, and my knowledge extends across various financial instruments. Now, let's delve into the concepts used in the article about money market funds:
Money Market Funds Overview: Money market funds are a type of mutual fund that focuses on short-term investments, including cash, commercial debt, and U.S. Treasury notes. They are known for being low-risk and highly liquid, providing stability to investors.
Mutual Funds: Money market funds are a subset of mutual funds, which are investment products that pool money from various investors to buy a diversified portfolio of stocks, bonds, or other securities. Mutual funds offer diversification, helping to spread risk across different assets.
Types of Money Market Funds:
- Government (or Treasury) Money Market Funds: Invest primarily in Treasury notes and bills, ensuring a high level of safety.
- Prime Money Market Funds: Hold commercial paper, certificates of deposit (CDs), and other short-term debt securities, considered low-risk "IOUs."
- Municipal Money Market Funds: Typically invest in tax-advantaged federal or state bonds or securities.
Investment Holdings and Quality: Money market funds exclusively invest in short-term debt securities with high quality, adhering to federal regulations. The weighted average maturity is limited to 60 days or less, minimizing the risk of default.
Returns and Risks: Money market funds offer relatively low returns, with the 7-day current yield typically ranging from 1% to 3%. While they are low-risk, they may not provide optimal long-term growth, making them suitable for specific investment goals or risk-mitigation strategies.
FDIC Insurance: Money market funds are not FDIC insured, unlike money market accounts. Investors should be aware that, despite the emphasis on capital preservation, there is still a chance of a money market fund losing value.
Differences from Money Market Accounts: Money market funds and money market accounts are distinct financial products. Money market funds are mutual funds with the potential for value fluctuations, while money market accounts, offered by banks, are FDIC-insured and do not lose value.
Pros and Cons:
- Pros: Low volatility, low risk, better returns than bank accounts, short duration providing liquidity, and potential tax benefits.
- Cons: Lower returns compared to other investment options, not FDIC insured, and returns may not keep up with inflation.
Fees: Money market funds do have fees, typically in the form of expense ratios. These fees are relatively low, considering the lower yields of money market funds.
Alternatives to Money Market Funds: Various alternatives include certificates of deposit (CDs), high-yield savings accounts, money market accounts, federal government bonds, and other fixed-income investments. Each alternative has its own set of pros and cons, catering to different investor needs and risk profiles.
Smart Investment Portfolio: Constructing a well-diversified portfolio is crucial, considering individual risk profiles, financial goals, and outlook. Money market funds may be suitable for certain objectives, but alternatives should be considered based on specific needs.
In conclusion, understanding these concepts is essential for making informed investment decisions, and consulting with a financial services professional can provide personalized guidance based on individual circumstances.