Money market funds, also known as money market mutual funds, are a very low-risk type of investment. Depending on your financial situation, they might even be an ideal investment. That’s why it’s so important to ensure that you understand the pros and cons. Let’s break down how money market funds work to give you a better idea of whether they’re right for you.
Money Market vs. Mutual Funds
Money market mutual funds are not the same as money market accounts. While often mistaken for one another, these are actually two completely different types of financial products.
A money market account is a particular type of interest-bearing savings account. Usually offered by a bank, money market accounts tend to be insured by the FDIC for up to $250,000 per depositor.
Mutual funds are, by definition, professionally managed pools of money from various investors, and a money market mutual fund is a particular kind of mutual fund.
The main difference between money market funds and mutual funds of other types is that, due to SEC stipulations, money market funds exclusively invest in low-risk assets, such as short-term debt.
While money market funds don’t offer FDIC protection, they are still considered one of the lower-risk investments available. They are also very liquid and can be easily bought and sold, making them a nice place to park your money without tying it up for a long period of time.
Just keep in mind that, much like stocks, once your money market funds are liquidated, they may need to be transferred to your regular bank account. In this respect, they are not quite as liquid as money market accounts, which often allow you to write a certain number of checks within a specified amount of time.
How Do Money Market Funds Work?
Investing in a money market fund is a bit like loaning someone money that you’re able to charge interest on. The managers of a money market fund take the cash that’s been invested and use it to purchase short-term debt.
They then collect interest on the debt and take out whatever percentage of fees they charge to manage the account. The rest of the interest money is then distributed among investors.
The good news is that money market funds don’t just take on anyone’s debt. They invest exclusively in the debt of very-high-credit entities such as government institutions and large corporations. There are three main types of money market funds, each of which is classified based on its investments.
- Government money market funds: Government money market funds primarily invest in government securities, such as treasury bonds or other government-backed securities.
- Prime funds: Prime funds are invested primarily in corporate debt. They may also invest in things like certificates of deposit (CDs), corporate notes or foreign issuers.
- Municipal funds: Also known as tax-exempt funds, these funds tend to invest in national or state municipal bodies with tax-exempt status.
Are Money Market Funds Good Investments?
This highly depends on what you’re looking to get out of your investment.
The biggest benefit of investing in a money market fund is that they tend to experience very little volatility. Whereas the stock market can experience drastic price swings, money market funds are relatively predictable.
The downside is that money market fund rates are far from spectacular. Even top money market funds tend to generate returns of around 2-3%, which is not much more than a high-yield savings account.
It’s also important to factor in that many money market funds charge fees, which may eat away at your earnings. Rising federal interest rates may mean that money market funds are able to offer higher returns in the future, but at the moment, they offer fairly slim returns.
Whether or not money market funds are for you will largely depend on your goals. If you’re looking for the potential for high rewards, then it’s probably best to look elsewhere. But if you’re looking for a low-risk place to stash your money for a while, then money market funds can offer slightly better returns than the average savings account.
How to Invest in a Money Market Fund
There are a few different ways to purchase money market mutual funds. One of the easiest is to purchase them directly through your online brokerage account. Simply select the fund you’re interested in and type its name or ticker symbol into your search bar just as you would if you were searching for a stock.
You can also purchase a money market fund directly from fund providers, such as Blackrock or Vanguard. It may also be possible to purchase a money market fund directly from your bank or financial institution, depending on which organization you use.
Additionally, you may want to consider purchasing money market funds through your IRA. This can be a nice way to round out a portfolio, especially when it comes to balancing out other investments with higher risk and reward potentials.
