Money Market Funds | Guide | What Is a Money Market Fund? What You Need to Know

Guide to Money Market Funds. What You Need to Know

Whether you’re a day trader or long-haul investor preparing for retirement, money market funds can play a significant role in any investment portfolio. However, the range of options and regulations can leave one wondering, “What are money market funds?”

Ranging in different sizes and types, a money market fund, commonly known as an MMF, can play several roles in your investment strategy. From long-term risk management to diversification or tax-free asset growth, there are many reasons for considering money market funds, but making the right choice from a list of money market funds is key.

This article will help you sort through the various consumer-level options available to pick the top money market funds for your needs. The rudimentary rules of smart investment always apply: stability and diversification should be the goal of any long-term investor, and money market funds have a place in that plan.

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We’ll be answering some of your key money market fund questions, including:

What is a money market fund?
Why should I invest in money market funds?
What are the basics of investing in a money market fund?
What sort of money market fund returns should I expect?
What are the top money market funds?

What Is a Money Market Fund?

Novice investors and experienced hands alike stand to benefit from money market funds, which have a very specific focus that makes them consistent, better short-term performers over common stock purchases or bonds. But what is a money market fund?

A money market fund, in some respects, mirrors a mutual fund in behavior and goals while investing in a completely different sector of the economy. A money market fund invests only in cash or cash-equivalent securities, also known as “money market instruments.” Money market fund returns typically outshine classic savings instruments, such as interest-bearing bank accounts, but do not have aggressive growth like their riskier counterparts.

Money market funds most often include:

Bankers’ acceptances
Certificates of deposit
Commercial paper (unsecured, very short-term corporate debt)
U.S. Treasury bonds
Repurchase agreements

Money market funds typically choose a pool of one of the above options and invest heavily in that field. Others, such as the “prime” class of money market funds, diversify across the entire spectrum.

A list of money market funds will show a whole range of options, including those which focus on government bonds, corporate debt or tax-exempt municipal securities. Some of the top money market funds heavily invest in corporate debt securities and are often referred to as “prime” funds.

Money market funds, in form and function, act like any other mutual fund. Investors buy into a money market fund via shares and pay fees to the brokerage managing the fund. Money market funds follow similar regulatory guidelines as mutual funds in nearly all aspects except when it comes to net asset value.

The U.S. Security and Exchange Commission has strict regulations in place for money market funds, some of them in response to the 2008 financial crisis. The regulatory agency requires, for example, that the securities within a money market fund have an average maturity of 90 days and fully mature within 397 days. It also sets high standards for the grades of debt contained within money market funds.

Asking “What are money market funds?” often leads to some mention of money market accounts, and it’s important to differentiate the two. Money market funds are carried by brokerages and do not guarantee any principal — the risk is essentially the same as any investment within your portfolio — while money market accounts are Federal Deposit Insurance Corporation (FDIC)-insured products, bearing slightly interest but with limited transactions.

Much like mutual funds, money market funds are not insured by the U.S. Treasury or FDIC should the firm guiding the fund go under or you incur any losses via the investment itself.

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Why Should I Invest in Money Market Funds?

Choosing from the top money market funds may seem like a tough endeavor, but nearly all offer the same upsides. A money market fund is (thanks to regulations and investment strategies,) safer, cheaper, and more versatile than your standard stock purchase or index funds. However, money market fund returns tend to underperform long term when compared to other options.

Investment institutions tend to favor money market funds for their limited exposure to downsides that plague other types of investments. Usually filled with highly-rated, safe debt, top money market funds limit losses caused by market volatility, bad credit and liquidity.

Money market funds offer six distinct advantages:

Stability: Money market funds rate among the least volatile of investment options, especially during sudden downturns and fluctuations in the market caused either by a stock calamity, a bank run or full-blown panic.

Security: Regulations dictate the funds be allocated in low-risk investments, making a money market fund more stable.

Short-term benefits: Most money market funds have a short duration – a few months at most, making them less prone to interest rate changes.

Diversification: Depending on the type of money market fund, most prime funds will be laced with a variety of cash-equivalent investments, making them safe from a market flash crash.

Taxes: Money market funds offer levy flexibility, with taxable and tax-free derivations.

Liquidity: The flexibility offered by a money market fund means assets can be shifted onto other investments with relative ease.

The securities contained in the top money market funds are mostly stable and safe. Even the largest money market funds, which can afford to take a few chances, generally contain low default-risk debt securities issued by banks, corporations and the government. While they may not contain the eye-searing returns of other, riskier investments, money market fund returns are some of the most dependable around.

This makes them one of the best places to temporarily park cash while deciding what gaps in your portfolio need to be filled. Do not lean on even the largest money market funds as a source of aggressive returns. The cash-equivalent investments contained within money market funds simply do not generate that sort of growth.

Money market funds have much lower initial purchase requirements than other cash-equivalent securities. This means the initial outlay into a money market fund will be much lower, but the financial benefit and money market fund rate will be stable.

Unlike other cash-equivalent instruments, money market funds do not have market timing restrictions; they can be bought and sold at any time. Some of the top money market funds also provide check-writing privileges, making them a viable backup to traditional bank accounts.

Unlike their mutual fund brethren, which have a settlement dates three days after the initial transaction, money market funds have same-day settlements. You can feel the benefits of money market fund returns flowing into your coffers the same day you buy into one.

This makes top money market funds the best place to put a sudden influx of cash – say, a bonus – to buy you some time until you figure out how to best spend it. Money market fund rates of return will never be their greatest strongpoint. Unless the Federal Reserve pumps interest rates up into the double digits, which is highly unlikely, even the largest money market funds will always remain the best “weigh station” for your assets while you decide what to do with them.

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What Are the Basics of Investing in Money Market Funds?

Money market funds come in several varieties:

Taxable: A taxable money market fund offers more flexibility and a greater array of cash-equivalent products. This sort of money market fund invests mainly in government agency or U.S. Treasury securities as well as repurchase agreements, certificates of deposit, and bankers’ acceptances. However, money market fund returns are subject to some state and federal taxes.

Tax-free: This variety of money market funds mainly dabbles in short-term debt issued in tax-exempt sectors such as municipal bonds. These money market funds rate lower and have a smaller yield than their taxable siblings, despite their tax-free status.

When deciding between the two, it’s best to determine which money market fund returns are higher. Typically, a taxable money market fund becomes more profitable as you move into higher tax brackets.

A third variant, “prime” money market funds, contain investments in dollar-denominated instruments provided by the Treasury and government but also include private sector sources, such as commercial paper, corporate notes, and certificates of deposit.

It’s also best to monitor the expense ratio when investing via money market funds. Many funds with a high level of activity and expenses can eat away at the relatively low money market fund returns.

Despite money market funds rates of steady returns, it’s important to not lean too hard on them as a singular source of long-term investment. Diversification, as always, remains key in any successful portfolio, and building your retirement fund solely around money market funds may hurt you in the long term, due to missed growth opportunities in other investment sectors.

What Sort of Money Market Fund Returns Should I Expect?

Money market fund rates have usually avoided “breaking the buck,” when an investment doesn’t maintain its initial value of $1 per share. Even though money market fund returns enjoy a history of relative stability, it’s not an absolute given. Only three money market funds have not been able to repay an investor’s full principal – when its net asset value dropped below its initial outlay – between 1983 and the financial crisis.

During the height of the 2008 financial crisis, the U.S. government had to institute a temporary insurance program to keep many money market funds from going under. It even set up a temporary insurance program — a de facto “bail out” for any money market fund which seemed on the verge of leaving investors in the lurch. Since the crisis, the federal government has set up new regulations to limited the amount of credit risk a money market fund can take on, among other changes.

“Breaking the buck” is such a taboo within the money market funds industry that companies have jumped in to prop up a fund’s value by infusing capital into it. The same goes for excesses in the fund which account for money market funds’ steady returns. Money market fund returns often include dividends paid out to investors in order to maintain a flat net asset value of $1.

Recent attempts to resuscitate the banking and financial sector, as well as the general economy, have lowered money market fund rates as well. In some cases, interest rates have dropped down to below a single percentage point, making money market funds much less profitable than they once were.

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What are money market funds good for? Even the top money market funds have a limited array of positives to offer. The limited volatility provided by money market funds make them a suitable investment if you:

Have a short-term investment goal and can tolerate a low yield
Are looking for one of the safer investment options to offset more volatile parts of your portfolio
Need a place to park assets short term which can be moved onto other investments in a snap

Be aware that some funds impose a fee on the sale of your shares, biting into your money market fund returns. Some companies may even temporarily suspend your ability to sell shares if the money market fund falls below its own minimums, thus further crimping your money market fund returns.

The safest route remains checking the contents of a money market fund yourself by looking at its prospectus. New regulations require greater scrutiny of investments by a money market fund’s board as well as more clarity for the consumer when buying into a fund.

Try to find money market funds sponsored by prime investment companies. As always, being an informed investor maximizes your money market fund rates of return.

What Are the Top Money Market Funds?

According to the Investment Company Institute, a private collective of U.S. companies which tracks investments, money market funds have dropped into the $2.7 trillion realm in total assets, from a high of $3.8 trillion before the financial crisis.

Investment in even top money market funds has slowed ever since the Federal Reserve dropped interest rates. In 2015, money market funds saw new inflows of $21 billion for the year, far from pre-crisis highs leading up to 2008.

On the list of money market funds, the top money market funds include:

From the above list, Vanguard and Fidelity are notable for their comparatively low expense ratio which keeps their money market fund returns relatively high. Such low fees mean expenses won’t eat away at the money market fund rates of return – your earnings remain yours.

Be prepared to also monitor inflation, as that can be as damaging to profits as low money market fund rates. If your earnings on a money market fund are 2% but inflation hits 3%, you’re losing real money in terms of purchasing power.

Demand from consumers has been fluctuating and is still volatile since money market fund returns remain relatively low. As a result, some of the largest money market funds folded or were taken over.

However, with the Federal Reserve hinting at higher interest rates, as well as the slow recovery of the general economy, money market funds may make a comeback and return to their former profitability. Money market fund rates are due to rise with any increase in interest rates.

Until those money market fund returns rise to their former glory, consider using money market funds primarily as a place to temporarily “park” funds, either from a sudden major sale, bonus or money waiting in the wings to be invested elsewhere.

The U.S. government provides a nifty fund monitor which tracks investments made by money market funds.

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