Looking for a safe, short-term, and liquid vehicle to park your cash in? Consider money market funds.
How’s your risk tolerance? If you want a super-safe place for your money or have short-term investing goals and want ready access to cash, you might think about money market funds (sometimes known as money market mutual funds). We’ll explain what these funds are, how they work, and explore their pros and cons, so you can make an informed decision about whether they are the right investment option for you.
What Is a Money Market Fund?
First off, it’s important to understand that a money market fund is not the same as a money market account. A money market account is a type of savings account in which you earn higher interest than traditional savings accounts and can write checks.
Money market funds are investment securities, not bank accounts, and they’re offered by many types of financial institutions, including banks, credit unions, brokerages, and mutual fund companies.
Like other types of mutual funds, money market funds are made up of a portfolio of securities and its shares are sold to investors. These investors earn returns from the portfolio in the form of interest. Money market funds offer extremely low volatility and superior liquidity, making them an attractive low-risk investment option. They provide a simple way for you to protect your reserves until you meet a short-term savings goal or are ready to invest them elsewhere.
Types of Money Market Funds
Let’s look at the three categories of money market funds available as defined by theU.S. Securities and Exchange Commission (SEC):
- Government (Including U.S. Treasury). This fund includes short-term government Treasuries, bonds, and repurchase agreements backed by Treasury notes. Regulations state that government funds must invest 95.5% of their assets in government-issued securities.
- Prime. These are also called general-purpose funds. Assets can be invested in government securities, as well as certificates of deposit, corporate notes, and other bank-debt securities.
- Municipal. Funds are invested in both national and state municipal bonds. This type of fund is sometimes called tax-exempt because the interest earned is exempt from federal income tax; state municipal bonds may be exempt from state income taxes if the investor lives in the same state.
Advantages and Disadvantages of Money Market Funds
Next, let’s explore the pros and cons of investing in money market funds.
- Very low risk. Money market funds offer excellent stability and are one of the least volatile types of mutual fund investments.
- Highly liquid. You can easily access your money from the fund, generally the next business day without incurring fees. This is an attractive feature if you need to pull cash to cover an emergency expense.
- Diversified. Money market mutual fund portfolios generally consist of many different securities, with a mix of U.S. Treasury securities, municipal bonds, corporate notes, and cash.
However, there are some disadvantages.
- Not government-insured. While money market accounts are insured by the Federal government for up to $250,000 per depositor, money market funds are not.
- No capital appreciation. Capital appreciation is the difference between the purchase price and the selling price of an investment. Money market funds generally have lower returns than other investments and aren’t a good choice for long-term savings goals, such as retirement.
- Inflation. How does inflation impact your investments? As inflation goes up, so do returns. Unfortunately, even though money market funds may earn more, rising inflation can eat up real returns. This is true not just for money market funds but for all investments.
When to Consider Money Market Funds
While money market funds aren’t the best option if you’re saving for retirement, they can make sense as part of your overall investment strategyor under these circumstances:
- Short-time horizon. If you have short-term savings goals such as building your emergency fund or saving for a down payment on a house, money market funds can be a good choice.
- Low tolerance for volatility. Risk-averse investors can keep their cash safe with low-risk money market funds.
- Need for liquidity. If you need ready access to cash, you can consider putting money into a money market fund with no fees associated with withdrawing money.
How Do You Buy Money Market Funds? Purchasing money market funds isn’t complicated. Keep in mind that a minimum deposit may be required unless you invest through an individual retirement account (IRA) or set up automatic monthly deposits. It’s a good idea to speak with a financial planner so you can make an informed decision.