What is a money market mutual fund?

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A common financial instrument that causes a lot of confusion among some investors is a money market fund. Many believe that these financial instruments are the same as similar-sounding money market accounts, which are very similar to savings accounts.

However, money market funds, sometimes referred to as money market mutual funds, are open-end mutual funds that invest in short-term securities. Investment professionals typically design them to preserve cash. Although money market funds carry a modest level of risk, they can produce higher returns while offering more security and liquidity than other fixed income investment vehicles.

These funds won’t make you rich, but they may meet the needs of some cash-oriented investors.

What is a money market fund and how does it work?

Money market fund managers invest in short-term, low-risk debt securities generally characterized by low volatility. These funds seek to trade at a fixed net asset value of $1 per share, with income being distributed to investors in the form of a dividend.

Although money market funds generally pay lower interest rates than some other fixed income investment vehicles, the tradeoff is their security and stability. Investors who need to save money for an emergency — or who simply want to store cash while they wait for their next stock investments — often choose money market funds.

However, it is important to note that unlike some other options, such as savings accounts, money invested in a money market fund is not protected by FDIC insurance.

When the funds fall below the benchmark index of $1 per share, this is called “breaking the ball”. It doesn’t happen often, but it did happen in September 2008 after Lehman Brothers went bankrupt. The crisis has caused some money market funds to fall to 97 cents per share. When this happened, the government stepped in and secured all stable value funds.

Despite this bailout, money market mutual funds generally do not benefit from insurance guarantees or government intervention.

So, what is a monetary fund used for? They are a relatively safe way to invest and are generally more stable and accessible than other investment options.

Types of Money Market Mutual Funds

What is an example of a money market fund? A variety of financial instruments can constitute a monetary FCP. The most common are:

Detail

Retail funds limit ownership to individual investors.

Institutional

As their name suggests, institutional money market funds serve institutions rather than individuals. Unlike most money markets, the net asset value here can fluctuate depending on market conditions. Companies and pension funds often buy this type of mutual fund.

Government

Government money market funds invest at least 99.5% of their funds in government securities. This usually means US Treasuries, but can also mean government-sponsored companies such as Fannie Mae and Freddie Mac.

Retail and institutional investors can purchase this type of money market fund.

Prime

Investment grade funds, sometimes referred to as “general purpose” funds, invest in short-term bank and corporate debt.

Municipal

Municipal money markets invest their assets in tax-exempt bonds issued by municipalities. These funds enjoy federal income tax exemptions and, in some cases, personal income tax exemptions.

Here is an overview of the different types of money market mutual funds:

Fund type Main types of instruments held
Retail funds Designed for individual investors; strives to maintain net asset value of $1 per share
Institutional funds Serves institutions such as corporations and pension funds; may have floating NAV
Treasury At least 99.5% invested in cash and US Treasuries, with at least 80% invested in Treasuries
Cash only At least 99.5% invested in cash, US Treasury bills and/or repurchase agreements, with at least 80% invested in Treasury bills and repurchase agreements
Government At least 99.5% invested in cash, US Treasury bills and/or repurchase agreements, with at least 80% invested in Treasury bills and repurchase agreements; this may also include government-sponsored companies such as Fannie Mae and Freddie Mac, but the US Treasury does not issue or guarantee these securities
Prime funds (general purpose) Assets invested in approved money market instruments denominated in US dollars, as defined by the SEC; this includes commercial paper, certificates of deposit, corporate notes, private instruments of foreign or domestic issuers and reverse repurchase agreements
National Municipal Invests at least 80% of fund assets in municipal securities whose interest is exempt from federal income tax
State Municipality Invests at least 80% of fund assets in municipal securities whose interest is exempt from federal income tax and personal income tax

Who might consider investing in a money market fund?

Most individuals and institutions who turn to money market funds have one thing in mind: capital preservation. But in most cases, account holders can have immediate access to their funds.

Additionally, money markets typically offer higher interest rates than standard savings accounts. And while money market funds don’t have FDIC insurance, they do have a high degree of security because they invest in very short-term, high-quality securities.

Considerations when investing in a money market fund

Although money market funds offer certain advantages that you cannot obtain with other financial instruments, these funds are not necessarily suitable for all fixed income investors. For this reason, individuals and institutions should consider the following:

Expense ratios

Expense ratios are the annual costs of owning a fund, and they are deducted from the income generated by the fund. Especially in a money market fund, where capital appreciation is not an option, a low expense ratio is essential.

Exposure

Even the safest funds have to deal with exposure and risk. Although money market funds are generally able to maintain a stable net asset value of $1, some funds may hold riskier assets than others.

Interest rate

One of the concerns of recent years has been negative interest rates. Funds need positive rates to generate the cash needed to cover their fees and payout returns to money market fund investors. However, with the Fed embarking on a cycle of aggressive interest rate hikes, this is now less of an issue – but still something to keep in mind.

Money market funds and money market accounts

While a money market fund is a mutual fund, a money market account works like a bank account.

Similar to savings accounts, money market accounts generally limit withdrawals to six per month – although this has been temporarily suspended due to COVID-19 – and they have FDIC protection. In this way, they function more like savings accounts than investment funds.

How to buy money market funds

Buying a money market fund is similar to buying a stock. You can simply log into your brokerage account and purchase the fund of your choice.

If you need help choosing the right money market fund, some online brokerages offer advice for a fee. Alternatively, you can find a fiduciary 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 large amount of cash. These funds won’t make you rich, but they will give you a relatively safe place to store funds and earn a modest return, often higher than that offered by a savings account.

John Csiszar contributed reporting for this article.

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About the Author

Will Healy is a freelance business and finance writer based in the Dallas area. He covered a variety of finance and current affairs topics, including the stock market, real estate, insurance, personal finance, macroeconomics and politics. Will holds a Bachelor of Science in Journalism from Texas A&M University, a Master of Science in Geography from the University of North Texas, and a Master of Business Administration from the University of Texas at Dallas.

Dolores W. Simon