Everything You Need to Know About Money Market Funds
Cassandra Kirby, CFP®, EA was recently quoted in this USA Today article titled “What is a money market fund?” and wrote this blog post as a follow-up piece with her full thoughts:
A money market fund is an open-ended mutual fund investing in high quality short-term debt securities, cash, and cash equivalents. An open-ended mutual fund is one that is priced and trades daily at net asset value. Short-term debt securities include United States Treasury Bills and commercial paper.
A money market fund is not the same as a money market account at a financial institution – it is an investment with daily pricing and fluctuation. While money market funds are not FDIC insured like bank assets, they are considered extremely low risk. A money market fund’s goal is to maintain a net asset value of $1 per share, with any excess earnings being distributed to investors in the form of dividends.
The minimum investment in a money market fund depends on the fund you are considering. Typically, minimums can range from $500-$5,000.
Types of money market funds
There are various types of money market funds, including Government money funds, Prime money funds, Treasury funds, and Tax-exempt money funds. Government money funds invest at least 99.5% of its total assets in cash and government securities. Prime money funds invest in floating rate debt and commercial paper. Treasury funds invest in United State Treasury issued debit securities (Treasury bills, Treasury notes). A Tax-Exempt money fund provides earnings that are not subject to federal income tax and may be a good option for an investor in a higher tax bracket.
Who they’re good for
Money market funds can be a safe and extremely low-risk place to park excess cash for a temporary period of time and in an attempt to drive interest earned on your portfolio/cash holdings. They pay better rates of interest than bank deposits like checking and savings/money market accounts and they are extremely liquid. Again, they aim to maintain a net asset value of $1 per share.
Disadvantages of money market funds
In periods of recession or volatility in monetary policy, a money market fund could “break the buck”, which is a term meaning that its value per share temporarily falls below $1. This type of situation is very rare. The most recent instance where this occurred was in 2008 after Lehman Brothers declared bankruptcy. Other disadvantages of money market funds include the fact that they are not FDIC insured.
In summary, money market funds can be beneficial for investors looking for safe and low-risk places to park excess cash or for those looking for better rates of interest thank bank deposits and savings accounts, as well as for investors in higher tax brackets.
As always, consult with your financial advisor before making any moves, and please do not hesitate to reach out if you have any questions.