What Are Money Market Funds?
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Money market mutual funds, also known as money market funds, are fixed-income mutual funds that invest in high-quality, short-term debt. They are considered one of the safest investments you can make, and with interest rates rapidly rising last year, they're more lucrative than they used to be. Some money market mutual funds are paying around 5% right now.
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How money market funds work
Similar to how other mutual funds work, money market fund investors buy shares in a fund, which in turn buys short-term government, bank or corporate debt, such as U.S. Treasurys, certificates of deposit or commercial paper. Money market funds are popular because they can quickly be turned into cash or used to fund a new investment opportunity.
Why invest in money market funds?
Money market funds are considered a good place to park cash, because they're much less volatile than the stock or bond markets.
Money market funds are used by investors who want to protect rather than grow their savings, but still aim to earn some interest. Typically, the interest rate paid by money market funds is on par with or slightly higher than bank savings or money market accounts. Money market funds are often used by investors to house cash holdings within brokerage accounts — investors may keep some cash in a money market fund, so it is ready to invest when opportunities arise.
They are cost effective because, unlike many mutual funds, they have no fees when your cash joins or leaves the fund. There also can be tax benefits, as some money market funds hold municipal securities that are exempt from federal and state taxes.
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What’s the downside of money market funds?
Lower long-term returns. Money market funds aren’t a great tool for building long-term savings, including retirement savings. The younger the investor, the more a portfolio should contain equity mutual funds, which are riskier but also have the potential for significantly higher annual returns. Money market funds often are best used when you’re in or near retirement, or when you're looking to stash money for a short-term goal.
» Learn more: The best short-term investments right now
No FDIC protection. Don’t confuse money market funds with money market accounts, which are bank savings accounts. Like other investments, money market mutual fund deposits are not protected, while money market accounts are backed up to $250,000 per depositor by the Federal Deposit Insurance Corp. at banks and the National Credit Union Administration at credit unions.
Like all investments, money market funds carry a risk of losing value. This is especially true as uncertainty swirls around the U.S debt ceiling. Still, money market funds are widely considered a safe alternative to bank deposits because federal laws require funds to hold only high-quality, short-term debt.
How to buy money market mutual funds
You can purchase from a fund provider such as Vanguard or Fidelity Investments, or directly from a bank. Both options, however, may limit your choices of funds.
You’ll have more choices if you open a brokerage account to begin investing. Money market funds often require a minimum deposit, but some providers offer a $0 minimum if you invest through an individual retirement account such as a traditional or Roth IRA, or if you set up automatic monthly deposits.
» Learn more: Understand how to invest with index funds.
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