Advantages of Money Market Funds

Money Market Funds Advantages and How to Invest

mattress-money market funds
Money market funds are smarter than mattress money!. Getty Images

If you have a mattress full of money, you might want to consider purchasing money market funds as a smarter alternative. Money market funds offer similar protection as the mattress, but also offer the benefit of earning interest on your money, with only slightly more risk.

What Is a Money Market Fund?

A money market fund is a mutual fund that invests in short-term, high-quality fixed income securities.

The goal of a money market fund is to have a net asset value that does not deviate from $1 per share. In other words, if you invest $1,000 in a money market fund, the goal is to return $1,000 plus a nominal yield (generally close to 90 day T-bill rates). Losses in money markets have been rare, but, unfortunately, they have occurred.

Money market funds are regulated by the US Securities and Exchange Commission (SEC). The SEC seeks to assure that risks are limited and investors’ interests are protected. Therefore money market funds can be a smarter alternative to your mattress, especially considering the fact that the latter means of saving carries the risk of theft or fire!

SEC Rule 2a-7 Governs Several Areas of Money Market Funds

  • Maturity of Holdings: Money market funds cannot hold investments with a maturity of greater than 397 days. The weighted average maturity of the portfolio cannot exceed 90 days.
  • Credit Quality: No less than 5% of a money market fund’s holdings may be in investments that are in the second-highest short-term rating categories.
  • Diversification: Money market funds are required to maintain a diversified portfolio. A money market fund cannot have any one holding that exceeds 5% of the value of the fund (with the exception of US Treasury and government agency holdings).

    Advantages of Money Market Funds

    The regulation of money market funds is the key to several advantages:

    • Safety: Preservation of capital the objective of money market funds. While a few money market funds have broken the buck (gone below $1) in most cases, the fund company or sponsor has stepped in to absorb the losses.
    • Liquidity: Money market funds provide excellent access to cash. Most brokerage accounts, including Schwab and Fidelity, offer a money market fund as a sweep option. In other words, when an investment is bought/sold money comes out of/goes into, the money market fund.
    • Yield: Money market funds pay a yield based on the holdings of the underlying fund. The yield is generally automatically reinvested into the fund via purchase of additional shares in the fund. This yield makes money market funds an attractive alternative to the mattress.

    As with all investing, it is recommended that you read the prospectus, along with other available shareholder reports and information.

    Updated by Kent Thune, April 28, 2016.