Money market funds, which are also referred to as money market mutual funds, provide a viable saving and investing alternative that banks, brokerages, and mutual fund companies offer. These funds are often deemed as low-risk investments that can cater to short-term investment objectives or establish an emergency fund. To understand how these funds operate, let’s delve into further details.
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 bills and commercial paper. The funds have historically tried to maintain a share price of $1 and there have only been two instances where a fund fell below that price, but there’s no guarantee 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 it is a government security. The weighted average maturity of a fund’s portfolio must be 60 days or less. These requirements help to maintain the overall liquidity of money market funds and ensure that the portfolio won’t be tied up in long-term investments.
There are a few different types of money market funds based on the security the fund invests in.
- Prime funds invest in floating-rate debt and commercial paper issued by companies, U.S. government agencies and government-sponsored enterprises.
- Tax-exempt funds are typically made up of municipal bonds and are exempt from federal income taxes and in some cases state taxes.
- Government and treasury funds invest in cash and securities that are backed by the government, such as U.S. Treasury bills.
Why You Should Consider Investing in Money Market Funds
Investing in money market funds can be a good choice for certain types of investors. Here are some reasons why you might want to consider investing in a money market fund:
- Low risk: Money market funds are considered to be low-risk investments because they invest in low-risk securities with short-term maturities. While there is still some level of risk involved, money market funds are generally safer than other types of investments, such as stocks or bonds.
- Short-term goals: Money market funds are a good option if you have short-term investment goals, such as saving for a down payment on a house or building an emergency fund. With maturities of 13 months or less, these funds are more liquid than longer-term investments and give you better access to your money.
- Better returns than traditional savings accounts: Money market funds offer higher interest rates than traditional savings accounts, making them a good option if you want to earn a little more on your savings.
- Tax benefits: Some money market funds invest in municipal securities that are exempt from federal and state taxes, which can provide tax benefits for investors.
Convenience: Money market funds allow you to write checks and make electronic transfers, making them a convenient option for accessing your savings when you need it.
For investors who prioritize preserving their capital and avoiding risks, money market funds can be a suitable investment option. Compared to traditional bank savings accounts, these funds offer a higher return on investment while still maintaining a low level of volatility, unlike stocks.
Apart from the benefits mentioned above, money market funds also allow you to write checks and perform electronic transfers. However, most accounts impose a minimum dollar amount for checks and may charge a fee after a certain number of withdrawals if the account balance drops below a specific level.
Additionally, certain funds may provide tax advantages if they hold municipal securities that are exempt from federal and state taxes. If you are saving for retirement or building an emergency fund, investing in money market funds may be an excellent fit to earn a modest return.
Are money market funds safe?
Money market funds are generally considered safe investments because they invest in low-risk securities with short-term maturities. These securities may include government bonds, certificates of deposit, and high-quality commercial paper. However, it’s important to remember that money market funds are still investments in securities that can lose value.
Another factor to consider is that money market funds are not FDIC-insured, even when purchased from a bank. Therefore, there is some level of risk involved. However, historically, this risk has been relatively low.
It’s also essential to understand that money market funds are different from money market accounts offered by banks. Money market accounts are FDIC-insured, whereas money market funds are not.
Money market funds invest in low-risk securities with short-term maturities, making them relatively safe. However, since they are still investments in securities, there is a possibility of losing value. While money market funds are typically regarded as safe investments, it’s essential to keep in mind that they are intended for short-term investment goals. These funds have maturities of 13 months or less, which makes them highly liquid and more accessible than long-term investments.
It’s crucial to differentiate between money market funds and money market accounts. Money market accounts are interest-bearing savings products that banks and financial institutions offer, which are FDIC-insured up to $250,000 per depositor, per insured bank. In contrast, money market funds (or money market mutual funds) are not FDIC-insured. Understanding the differences between these options is essential in determining the best fit for your investment objectives.