Advantages of Money Market Funds
Money Market Funds Advantages and How to Invest
Money market funds offer higher yields than savings accounts but are relatively safer than bonds. Therefore, if you're looking for a combination of safety and higher interest rates, money market funds can be a smart place to keep your short-term savings or emergency fund.
There are many types of money market funds for many types of investors. Some funds invest in U.S. Treasuries, while others might invest in riskier options, with correspondingly higher interest rates. Carefully investigate any fund you're considering.
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!
The SIPC may protect against a customer's loss of cash and securities at a SIPC-member brokerage firm. Money market funds are considered securities, not cash. So, this protection is not the same as an FDIC-insured bank account; it doesn't provide protection for value declines, credit risks, or unexpected fees.
SEC Rule 2a-7 Governs Several Areas of Money Market Funds
As a result of the last financial crisis, the SEC introduced new rules to attempt to safeguard investors with money market funds, including:
- 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 individual 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. Some brokerage accounts offer a money market fund as a sweep option. In other words, when an investment is bought or sold, money comes out of or 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.
Read the prospectus before investing in money market funds, along with other available shareholder reports and information.
The Bottom Line
Money market funds can be smart saving and investing tools for individuals who want to earn higher interest rates than bank accounts but also want something safer than bonds. As with all types of investment securities and savings tools, money market funds may not be right for all investors.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.