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Updated on Monday, March 25, 2019
No matter what level investor you are, similar-sounding terminologies, acronyms and labels can cause confusion about what sort of product would best serve you. That may be especially true when investing products have similar names to banking products, as in the case of money market mutual funds.
What is a money market mutual fund?
One huge hurdle to investment education that many beginning investors come across as thinking they have familiarity with a term — only to realize the term they’re thinking of is a similar sounding product with very different goals and outcomes. Such is often the case when people come across money market mutual funds and assume they operate in the same way as a money market savings account.
While a money market account is a savings vehicle that usually has higher interest rates than traditional savings accounts, a money market mutual fund is an investing product. Unlike a money market account, whose value does not lose or gain money in market fluctuations, a money market fund is a type of mutual fund that can lose or gain value.
However, money market funds are typically low volatility because the funds must follow industry-standard regulatory requirements. Investors may choose a money market mutual fund over a money market savings account because the gains in the account could potentially be higher than interest earned.
Why are money market funds useful?
While there’s always a risk of losing money in any sort of investment, many investors choose money market mutual funds because they may be less risky than other options. In addition, money market funds offer a high degree of liquidity, making it easy for investors to withdraw assets if cash is needed.
Money market mutual funds also appeal to investors because they offer diversification; the funds tend to hold many different securities, which may include short-term U.S. Treasury securities, Eurodollar deposits, CODs, and corporate commercial paper. Federal regulations of money market funds require that investments be short-term with minimal credit risks.
Money market funds are seen by some as an in-between investment option that straddles a savings account and an investment account. Some think that the liquidity of a money market fund make it a good place to keep emergency savings, tuition payments or other money that needs to stay relatively liquid, but isn’t being touched on a daily basis. While the dividends in a money market fund may be slightly higher than the interest generated by a money market account at a bank, dividends and gains may not be as high as they would be in other investment products.
As a point of comparison, it’s not uncommon for money market fund yields to be somewhere between 2 and 3%, while a money market account at a bank may have an interest rate between 1 and 2%. Also good for potential investors to consider — depending on the money market fund and the securities the fund invests in — the income made from the fund may be tax-exempt.
What kind of money market funds are there?
According to the Investment Company Institute, there were 421 money market mutual funds at the end of 2016, accounting for about 5% of the 8,066 mutual funds available to investors. While all money market funds have to meet the same federal regulations based on credit quality and length of maturity, the focus of funds differ. The best money market funds for each investor depends on the individual’s goals and investment strategies.
In 2016, responding to issues that arose during the 2008 financial crisis, the SEC made significant rule changes to money market funds. The changes included clearly delineating three fund categories; limiting the types of funds in which corporations could invest; and allowing institutional funds to have a floating net asset value (NAV), similar to other mutual funds, rather than a stable $1 asset value.
The categories of money market mutual funds include:
- Government money market funds: These funds have several subcategories, including Treasury-only, Prime, or Municipal. In particular, some people are interested in these funds because municipal funds, sometimes called tax-exempt funds, may have federal or state tax exemptions. These funds may be purchased by individuals or investing groups.
- Retail money market funds: These funds are limited to individual investors rather than an institution, and have a NAV of $1 a share.
- Institutional or prime money market funds: This class of funds tends to be for institutions and corporations rather than individual people. While retail funds have a stable NAV of $1 a share, institutional money market funds have a floating NAV, which means that these funds may fluctuate more depending on the strength of the market.
How do you buy money market mutual funds?
Before you open your account, it’s important to know what your goals are. Are you planning for it to be emergency savings or a place to hold money for a big ticket expense, like college tuition or a tax bill? How much money do you plan to keep in this account? All of these questions can help you decide which sort of fund is right for you, as well as whether the benefits of a tax-exempt account may be something worth considering.
Usually, a brokerage will offer several fund options, and as with any investing product, it’s up to you to research past performance to decide which option is best for you. An independent financial counselor or certified financial planner may also be able to give advice as to the best option for your financial situation.
Is a money market fund right for you?
The combination of stability and liquidity offered by a money market fund, as well as relatively reliable returns compared to other investments, are all reasons investors are attracted to money market funds. In addition, if you already have an investment account at a brokerage, a money market fund can be a convenient way to manage money, including settling brokerage trade fees or having a place to “park” money after a sale.
The rate of return on a money market fund may be less than the forecasted return of other investment products, and it may make sense to explore options with a more aggressive rate of return if you’re planning for retirement or saving for college tuition. If you’re hoping to invest in a product with a higher rate of return, it may make sense to explore other mutual fund investment products.
While a money market fund can be a smart alternative or addition to a traditional savings or money market account, it’s important to remember that money market funds are still investments. Some people prefer to leave their liquid cash in an FDIC-insured account, and as online savings accounts increasingly offer competitive interest rates at or above 2%, comparing account structures, fees and performance between money market accounts and money market funds may make sense for investors who want a safe place to stash their cash.