Money Market Fund: Definition, Types, Advantages & Risks

money market funds

Money Market Fund: Definition, Types, Advantages & Risks

Money market funds are practical tools that can be included in nearly any type of investment strategy. To determine whether and how these funds fit within your investing goals, you must first comprehend their nature. Many money market funds invest in high-quality, short-term instruments. These funds offer a balance of safety and liquidity, making them a popular choice for conservative investors.

A Money Market Fund: What Is It?

A mutual fund that only makes investments in cash and cash equivalent securities—also known as money market instruments—is known as a money market fund. These short-term investments have excellent credit quality and are very liquid.

Money Market Funds vs. Money Market Accounts

Despite their striking similarities, money market funds and money market accounts (MMAs) are not the same thing. The primary distinction is that the latter are interest-earning savings accounts provided by banking institutions, with restricted transaction rights and Federal Deposit Insurance Corporation (FDIC) insurance, whilst the former are sponsored by fund firms and do not have a principal guarantee. 

A money market account often offers a little lower interest rate than a CD or the total return of a money market fund, but a higher interest rate than a bank savings account. Furthermore, while money market fund withdrawals are typically available upon request, money market accounts limit the ability to access account balances through check writing. 

Certain banks might give up some MMAs allowing up to six withdrawals per statement cycle, while others don't allow check writing at all. Although they need checks to be made for a minimum amount, many money market funds allow limitless check writing.

Features That Set Money Market Funds Apart

Three factors make money market funds unique:

1. Safety

These funds make investments in stable and typically secure securities. Money market securities have short maturities and a fixed return. By investing in bank-issued debt instruments, Money market funds for the government and big businesses have a low default risk and nevertheless provide a respectable return.

2. Minimal Initial Outlay

The great majority of individual investors find it difficult to purchase money market assets due to their often high minimum purchase requirements. The minimal requirements for money market funds, on the other hand, are significantly lower and even lower than those of typical mutual funds. Consequently, investors can benefit from the safety associated with money market investments at lower thresholds thanks to money market funds.

3. Availability

Shares of money market funds are not restricted by market timing and can be purchased and sold whenever you choose. The majority of these funds allow investors to write checks and offer same-day settlement, which is comparable to trading securities in the money market.

Risks of Money Market Funds

Every asset has limitations. Three things to consider before investing in a money market fund are:

  • Expense Ratio: Money market funds incur costs, just like traditional mutual funds. Generally poor returns will be eroded by a fund with an expense ratio that is greater than normal.

  • Investment Goal: A sizable holding in money market funds is inappropriate if you are a long-term investor creating a retirement fund. These funds typically produce income that is only marginally higher than inflation, which is insufficient to create a sizable nest egg. Rather, money market funds have to be utilized as a tool for managing a portfolio in order to temporarily park funds or amass funds for a planned cash outflow.

  • Interest Rate Risk: Although money market funds are considered to be low-risk, they are not immune to interest rate changes. The yields on money market funds may lag behind in increasing when interest rates increase, which may lead to lower returns compared to other cash investments such as online savings accounts or CDs that respond more quickly to rate changes.

  • Liquidity Risk during Crisis Situations: Though money market funds are generally structured to provide high liquidity, extreme financial instability or market stress may restrict redemptions or impose fees to preserve cash in the fund. This can effectively limit the investor's access to his money when it is most needed.

The Bottom Line

Make sure you learn as much as you can about a given fund, whether you choose to use money market funds as an investment vehicle or as a short-term holding area while you wait for the right security to purchase. Money market funds are frequently promoted as being identical to money. They're not. It's not an investment, and you wouldn't want it to be. Checkout JS Bank’s various investment options for greater returns.

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