What Is a Money Market Fund?

Investing in mutual funds is a popular way for investors to diversify their portfolios. However, there are many types, each with varying risks and benefits. One important variant is a money market fund, which typically invests in short-term securities.

This article will explain how money market funds work, including what they invest in and the different types. You’ll also learn the notable benefits and risks to consider before you decide to buy shares. Finally, we’ll break down how you can invest in one through a brokerage firm.

How Money Market Funds Work

Money market funds are professionally managed portfolios of high-quality, short-term securities. This typically includes assets like U.S. Treasury Bills, commercial paper, certificates of deposit (CDs), or corporate bonds that mature within a year. Additionally, many funds maintain a net asset value (NAV) of 1.00 per share to minimize losing money.

The purpose of a money market fund is to provide investors with a high level of liquidity with a relatively low risk. To maintain this standard, regulatory authorities, such as the U.S. Securities and Exchange Commission (SEC), require funds to maintain a base level of liquidity at all times. Per Blackrock, money market funds typically must “invest at least 10%” in securities “that can provide daily liquidity,” and another “30%” toward assets that grant “weekly liquidity.”

For investors, money market accounts are a common way to allow money to generate returns while keeping it highly liquid and relatively safe from risk. Per Vanguard, money market funds “pay a higher yield” than a savings account or CD (based on the seven-day SEC formula). Because of this, they’re often a popular choice for investing in the short-term, such as saving for a big purchase or emergencies.

As an example of money market fund returns, imagine that you placed $20,000 in one at a 3% yield. In this instance, a fund would produce about $600 each year.

Money Market Fund vs. Account

You’ve likely also heard of a money market account. While this sounds the same, it is a different type of financial tool than a money market fund. The former is a type of bank savings account that typically yields a higher interest rate – with an average of 0.66% APY as of July 2024, according to the Federal Deposit Insurance Corporation (FDIC). Meanwhile, the latter is a type of mutual fund, which aims to invest in liquid and short-term securities.

Besides the name, the key similarity is that both are used as short-term investing solutions. This is because each is highly liquid and tends to generate better returns than a typical savings account.

Types of Money Market Funds

There are different types of money market funds, categorized by what each primarily invests in. Below is a breakdown of the four core classifications:

Taxable

Taxable, or prime, money market funds generate income subject to taxes. They typically invest in corporate and bank debt. Generally, these types generate higher yields than others. For example, Schwab Value Advantage Money Fund – Ultra Shares (SNAXX) generates a 5.29% 7-day return, which is in high contrast to 3.09% with Schwab New York Municipal Money Fund – Ultra Shares (SNYXX), a tax-exempt fund.

Tax-Exempt

Tax-exempt, or municipal, funds provide tax-free earnings to shareholders. Typically, they invest in municipal bonds or other government securities.

Government

Government money market funds exclusively invest in securities owned by the federal government. For example, one might invest solely in Treasury bonds. Because they depend entirely on the U.S. government, these funds are widely regarded as highly safe from risk.

Retail

Retail money market funds invest in high-quality corporate bonds, municipal bonds, and other short-term securities. Additionally, these are typically only available to natural persons, rather than a company or entity.

Benefits and Risks of Money Market Funds

Money market funds are a popular way to set cash aside while being confident that they can gain positive returns in the meantime. They also provide a high level of liquidity, which can benefit investors. However, there are disadvantages, such as smaller returns than other investments and a lack of FDIC insurance.

Below is a breakdown of the benefits and risks to consider before parking your money in a money market fund:

Purpose of Money Market Funds

The liquidity and low risk that money market funds provide make them ideal for many investors. They offer a place to let your cash sit and earn positive returns from dividends while being very accessible. For these reasons, many choose them either in tandem or as an alternative to a savings account.

However, it’s important to consider that while the returns may yield more than a savings account, the funds aren’t FDIC insured. Gains are also mainly from dividends, which limits how much you can make. This makes a money market fund more of a tool for short-term goals rather than more lofty ones, such as retirement.

Before incorporating money market funds into your investment strategy, we recommend you speak with a financial advisor. They will help you visualize how it may help you reach your goals and avoid crucial mistakes. To find a high-quality professional in your area, consider using this free matching tool. After filling out a short quiz about your finances and goals, it will present you with an expert tailored to your needs.

How to Invest in One

You can invest in a money market fund through a taxable account or a tax-advantaged retirement account, such as a Roth IRA or 401(k). You can typically set any one of these up at a brokerage firm of your choice. Prominent ones include:

• Vanguard
• Fidelity
• Charles Schwab
• Merrill Lynch
• J.P. Morgan

From there, it’ll be up to you to select which money market fund to invest in. Having a financial advisor on your side can help ease this process because of the expertise they bring to the table. Either way, be sure to conduct sufficient research, paying close attention to factors like past performance and the type of fund it is, before buying any shares.

Frequently Asked Questions

Are money market funds insured?

The FDIC doesn’t insure money market funds; however, they are typically SIPC-insured up to $500,000, which protects investors if the brokerage firm runs into financial trouble.

Do money market funds lose money?

A money market fund can lose money or “break the buck” in some instances. However, this is a rare occurrence that usually only happens during financial crises, such as the 2008 recession. Normally, these funds don’t fluctuate in price and stay around $1 per share.

Are money market funds liquid?

Money market funds are highly liquid investments. They allow you to sell off shares and access your money easily. Keep in mind, however, that it may take a couple of days to receive your cash, depending on the brokerage firm.

What do money market funds invest in?

This depends heavily on the type of money market fund; however, they typically invest in short-term securities, such as corporate or municipal bonds.