Money market funds are a type of mutual fund that relies on specific short-term investments, like cash, commercial debt, and U.S. Treasury notes. They are considered low-risk, and they provide high liquidity. They are not the same as money market accounts.
What are money market funds?
As soon as you begin researching investment options, you’ll run into an endless stream of terms and products that can quickly become overwhelming. Money market funds are best suited for certain narrow investment uses. Read on to fully understand how money market funds can be used to your advantage.
Money market funds are a type of mutual fund. A mutual fund is aninvestment productthat bundles many different investments. For example, instead of buying a single share in a company, you can purchase fractions of shares in many companies. This makes mutual funds good for diversification and helps insulate your investments should there be changes in the market.
Money market funds are different than most mutual funds, however. Instead of purchasing fractions of common stocks, you’re buying a stake in high-quality, short-term cash and debt securities.
Money market funds definition:
Federally regulated mutual funds that invest in U.S. Treasuries, commercial paper, and other short-term debt securities.
What do money market funds invest in?
They’re invested almost exclusively in types of debt securities with short maturities. All money market fund investments are required by federal regulation to be high quality and to have a weighted average maturity of 60 days or less. There’s little chance of default, and the risks are low. Here are some of the common types of money market funds:
Government (or Treasury) money market funds:These are mostly invested in Treasury notes and bills, but they can include other vehicles, like bonds or repurchase agreements.
Prime money market funds:These hold mostly commercial paper, which can include certificates of deposit (CDs), banker’s notes, and other short-term debt securities. Some think of them as low-risk “IOUs” that trade among financial institutions.
Municipal money market funds:These usually hold tax-advantaged federal or state bonds or securities.
How good are money market fund returns?
The 7-day current yield of money market funds is typically around 1% to 3%. Considering that well-diversified stock portfolios often target 8% to 10% growth (with much higher risk profile, of course), investing primarily in money market funds isn’t always an optimal long-term investment strategy. Money market funds are usually used as a targeted investment strategy with considered goals, like mitigating the risk of a potential bear market or parking extra money is a safe spot while awaiting an investment opportunity. Keep in mind that with such low yields inflation can play a significant role in your returns. If inflation is rising above or is near the yield of your money market fund, it can wipe out most (or even all) of your gains. If inflation is steady, or falling, money market funds may be more attractive.
Are money market funds FDIC insured?
No. Even though the primary investment objective of many money market funds is capital preservation, as with most investments, there is a chance a money market fund can lose value. Money marketaccountsare FDIC insured. See the next point to understand the difference.
How are money market funds different from money market accounts?
Due to the similar names, there is often confusion between these two types of financial products. They are not the same. Money market funds are a type of mutual fund, which is an investment product and has the possibility of losing money. Money market accounts are a type of savings account offered by a bank that is FDIC-insured, so it will not lose value. Because of their added safety, money market accounts often have an even lower projected return than money market funds.
Should I invest in money market funds?
Money market funds are generally used by investors who have a low risk tolerance (like those with enough savings who are already in retirement) or investors who are looking for a temporary place to park money. Because their returns tend to be small, money market funds are generally not a sound long-term retirement savings tool. That said, they can be used as a risk-mitigation tool in a well-diversified portfolio.
Whether or not they are right for you will depend on far too many factors to fully cover in this article. Your best option is to discuss your strategies with a financial services professional. In addition to guidance on money market funds, we have awide selection of mutual fundsyou can invest in.
Do money market funds have fees?
Yes, but they tend to be low, considering the lower yields of money market funds. These fees, as with fees for most mutual funds, are in the form of expense ratios. It’s important to take the cost of mutual funds into account when comparing potential investments.
Pros and cons of money market funds
While money market funds are considered to be extremely low risk investments, they may not be your best option, because the returns are often quite low. Here are some of the other things you should keep in mind:
Pros:
- Low volatility and low risk
- Better returns than bank accounts
- Short duration provides liquidity
- Diversification
- Potential tax benefits
Cons:
- Lower returns than with other equity and fixed income mutual funds
- Not FDIC insured
- Returns may not keep up with inflation
- Changes to financial rules and regulations can pose a risk
Are there alternatives to money market funds?
Yes. There are many options that have similar rates of return, and each has different pros and cons. Certificates of deposit (CDs) are FDIC-insured and can have similar returns, but they lack the liquidity of money market funds. With CDs, you’re locked into a time period, and you will usually face penalties for early withdrawal. High-yield savings accounts may give you some of what you’re looking for, but they often have high balance requirements. Money marketaccounts, as we’ve said previously, are similar to savings accounts, but with different rules and benefits. Federal government bonds, as well as mutual funds that deal exclusively in government debt, are backed by the federal government, but they may have rules on how and when you can cash them in and are subject to market volatility. Fixed income investments are also subject to credit and interest rate risk.
Making a smart investment portfolio
Choosing the right investments depends on your risk profile, situation and outlook. If you’re saving for retirement, you’ll first want to get a better understanding of how much you currently have saved versus how much you’ll need. Then, you can begin to build a strong, diversified portfolio to help meet your goals. The good news is that you don’t have to figure everything out for yourself. If you’d like to discuss your plans and develop a custom retirement strategy, afinancial services professionalcan help.
1Diversification does not assure a profit or protect against market loss.
You could lose money by investing in the Fund. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. The Fund may impose a fee upon sale of your shares or temporarily suspend your ability to sell shares if the Fund's liquidity falls below required minimums of market conditions or other factors. An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Fund's sponsor has no legal obligation to provide financial support to the Fund, and you should not expect that the sponsor will provide financial support to the Fund at any time.
Investments are offered through NYLIFE Securities LLC (MemberFINRA/SIPC), a Licensed Insurance Agency and a New York Life Company.
As an experienced financial professional with a deep understanding of investment products and strategies, I can confidently provide insights into the concepts discussed in the article about money market funds.
Money Market Funds Overview: Money market funds are a type of mutual fund that focuses on short-term, low-risk investments such as cash, commercial debt, and U.S. Treasury notes. They are known for providing high liquidity and are distinct from money market accounts.
Mutual Funds and Diversification: Mutual funds, in general, pool together various investments to offer diversification. Money market funds, however, differ from traditional mutual funds as they invest in high-quality, short-term cash, and debt securities.
Types of Money Market Funds:
- Government (or Treasury) Money Market Funds: Invest in Treasury notes and bills, ensuring a focus on security.
- Prime Money Market Funds: Primarily hold commercial paper, including certificates of deposit (CDs) and short-term debt securities.
- Municipal Money Market Funds: Invest in tax-advantaged federal or state bonds.
Returns and Risk: Money market funds typically yield 1% to 3%, providing lower returns compared to well-diversified stock portfolios. While they are low-risk, inflation can impact returns, and they are not FDIC-insured.
Comparison with Money Market Accounts: Money market funds are different from money market accounts, which are FDIC-insured savings accounts offered by banks. Money market accounts are considered safer but offer lower returns.
Considerations for Investors:
- Suitability: Money market funds are suitable for those with low risk tolerance or looking for a temporary place to park money.
- Long-Term Strategy: They may not be ideal for long-term retirement savings due to lower returns.
- Inflation Impact: Inflation can erode gains from money market funds with low yields.
Fees: Money market funds have low fees, typically in the form of expense ratios. Considering the lower yields, investors should factor in these costs when comparing potential investments.
Pros and Cons: Pros:
- Low volatility and risk.
- Better returns than traditional bank accounts.
- Short duration provides liquidity.
- Diversification benefits.
Cons:
- Lower returns compared to other equity and fixed income mutual funds.
- Not FDIC-insured.
- Returns may not keep up with inflation.
Alternatives to Money Market Funds: Several alternatives with similar rates of return include certificates of deposit (CDs), high-yield savings accounts, money market accounts, federal government bonds, and fixed income investments. Each option has its pros and cons, considering factors like liquidity, penalties, and market volatility.
Building a Smart Investment Portfolio: Choosing the right investments involves assessing risk profiles, financial situations, and long-term goals. Diversification is crucial, and investors can seek guidance from financial services professionals to tailor a portfolio that aligns with their objectives.
In conclusion, while money market funds offer low-risk and liquidity, investors must carefully consider their financial goals, risk tolerance, and the broader investment landscape to make informed decisions.
