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Money market funds – also called money market funds – are a savings and investment option offered by banks, brokers and investment funds. These funds are considered low-risk investments that may be suitable for short-term investment goals or for building an emergency fund. Here you can find more information about how they work.
How money market funds work
Money market funds are regulated by the Securities and Exchange Commission, or the SEC, and are required to invest in short-term debt securities, such as certificates of deposit, U.S. Treasury bonds, and commercial paper. The funds have historically tried to maintain a share price of $1 and there have been only a few instances where a fund fell below that price, but there is no guarantee that a fund will be able to do that.
Money market funds are required to purchase securities with maturities of 13 months or less, or in some cases 25 months if the security is a government security. The weighted average duration of a fund’s portfolio must be 60 days or less. These requirements help maintain the overall liquidity of money market funds and ensure that the portfolio is not tied up in long-term investments.
Types of money market funds
There are a number of different types of money market funds, depending on the security in which the fund invests.
- Excellent funds investing in variable rate debt and commercial paper issued by corporations, U.S. government agencies, and government-sponsored enterprises.
- Tax-exempt funds generally consist of municipal bonds and are exempt from federal income taxes and in some cases state taxes.
- Government and treasury funds investing in cash and securities backed by the government, such as U.S. Treasury bonds.
Reasons to invest in money market funds
Investors who are particularly risk-averse and focused on protecting their nest eggs may find that money market funds meet their investment needs. The funds can help you generate returns in excess of what traditional bank savings accounts offer, but will have significantly less volatility than, for example, stock market investments.
Money market funds allow you to write checks and make electronic fund transfers, but most accounts require a minimum dollar amount for checks. Check with your institution to see if it will charge you a fee after a certain number of withdrawals if your account balance falls below a certain level.
Some funds even offer tax benefits if they hold municipal securities that are exempt from federal and state taxes. If you want to generate a small return during retirement or simply save for a rainy day, money market funds can be a great fit.
Are money market funds safe?
Money market funds are relatively safe because they invest in low-risk securities with short durations. That said, it is still an investment in securities that can lose value. Money market funds are generally considered safe investments, but it is important to remember that these investments are intended for the short term. With terms of 13 months or less, the funds remain liquid and give you better access to your money than longer-term investments. A crucial distinction investors need to make is the difference between money market funds and money market accounts.
Money market accounts are interest-bearing savings products offered by banks and other financial institutions. These accounts are FDIC insured up to $250,000 per depositor, per insured bank. Money market funds (or money market investment funds) are not. It is important to know which option best suits you and your investment goals.
Disadvantages of investing in money market funds
The main negative of investing in money market funds is that you will not earn sufficient returns to build wealth over time, or even beat inflation. This fact makes these funds unsuitable for long-term savings goals such as retirement. Investing in the stock market probably makes more sense for young people who are investing to achieve goals that are still decades away. But for those who are already retired or if you are just saving, money market funds can be a good solution.
Another disadvantage is that money market funds are not FDIC insured, even if you buy them from a bank. That means there is some risk, but historically it has been small. You may find that the small risk is worth it because money market funds traditionally pay a better interest rate than a traditional savings account.
Keep in mind that money market funds are different from money market accounts that banks offer as a savings instrument. The accounts offered by banks are covered by FDIC insurance up to $250,000 per depositor, per insured bank, but the funds are not.
Finally, you’ll want to keep an eye on the expense ratios of the funds you invest in. With the often low expected returns, costs can eat up a large percentage of your returns if you are not careful. The average money market fund charged 0.13 percent in 2023 report of the Investment Company Institute. That means you pay $13 for every $10,000 you invest in a fund. Information about the fees can be found in the fund’s prospectus or via your online broker.
How to Invest in Money Market Funds
You can buy money market funds in different ways. You can go directly to a fund provider such as Vanguard or BlackRock, buy it through a bank or through your online investment account. You’ll likely have most of your options through an online broker, who will likely have funds available from a number of different providers.
If you plan to invest in the funds as part of a retirement strategy, consider purchasing through a traditional or Roth IRA to limit your taxes on gains and withdrawals.
In short
Money market funds won’t make you rich, but they do offer a small return in a low-risk way, making them a good fit for retirees and people saving for short-term goals or building an emergency fund.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making any investment decision. In addition, investors are advised that the past performance of investment products does not guarantee future price increases.
