Money Market Funds: What They Are and How They Are Used
Money market funds play an important role in portfolios by providing liquidity, stability, and modest yield. They are widely used by individuals, advisors, institutions, and brokerage firms as a place to hold cash that earns interest while remaining accessible.
What a Money Market Fund Is
Although they are often thought of as “cash,” money market funds (MMF)are actually mutual funds that invest in high quality and very short-term debt instruments designed to maintain a stable value.
Income is distributed as dividends, typically daily and paid monthly.
A unique mandate of most money market funds is maintaining a stable Net Asset Value (NAV) of $1 per share. The NAV is just the price you see for the fund. This differs from other ultrashort investment options that can have some variation in the price – even if it is small.
The money market fund is fully liquid meaning you can buy and sell it at any time. Unlike investments like Certificates of Deposits (CD), you are not locked into a holding period.
Money Market Funds do have to meet different regulatory requirements related to daily and weekly liquidity, credit quality, and maturity guidelines.
Types of Money Market Funds
There are some variations on money market funds that you might see based on what they actually own.
Government Money Market Funds
Government funds invest primarily in:
- U.S. Treasury securities
- Government agency securities
- Repurchase agreements backed by government collateral
These are generally going to be the lowest credit risk but also lowest yield.
You will even see Treasury Money Market Funds which only invest in US Treasuries.
Prime Money Market Funds
Prime funds invest in corporate short-term debt, including:
- Commercial paper
- Bank obligations
- Corporate floating rate notes
These will be higher yielding than the government money markets but still maintain a high credit rating.
Tax-Exempt (Municipal) Money Market Funds
Finally, municipal money markets invest in short-term municipal securities. These will distribute federally tax-exempt income and may provide higher after-tax yields depending on your tax bracket.
The Returns on Money Market Funds
Generally, you’ll receive a rate consistent with short term interest rates. The current rate will adjust on a regular basis – up or down – based on current economic conditions.
The federal reserve has a large impact on the rate charged as changes to the Fed rate impact the underlying investment yields heavily.
Generally, money markets will earn higher yields than checking and savings accounts. High Yield Savings accounts will be a competitor.
Why Advisors and Investors Use Money Market Funds
Money market funds serve several practical purposes in portfolios.
Cash Management
Investors often use them to:
- Hold idle cash
- Store funds awaiting investment
- Manage liquidity for withdrawals
Portfolio Rebalancing
They provide a temporary parking place for proceeds from trades.
Short-Term Savings
Money markets can be used for Emergency funds, Near-term expenses, and Tax reserves.
Retirement Withdrawals
Money Markets Funds can play an integral role in managing cash for distributions when withdrawing for retirement.
Are They Safe
Money market funds are generally considered safe particularly if you utilize Treasury Money Markets. However, there have been risks in the past.
In the 2008 financial crisis, the Reserve Primary Fund fell below $1 after exposure to Lehman Brothers debt.
Money Market funds are also not FDIC insured like a high yield savings account, checking accounts, savings account, or CD’s.