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Money market funds are an alternative to savings accounts and a relatively safe place to hold money you don’t need immediately, such as an emergency fund. These funds offer liquidity, which makes them adequate for investors who want access to their money relatively fast when needed.
Unlike money market accounts, which are deposit accounts that pay interest on your balance, money market funds are an investment product. As such, they aren’t protected by deposit insurance. However, they can be a good option when interest rates are high. But, how to invest in money market funds?
Read on to learn more about money market funds, how they work, how to invest in them and what factors to consider when choosing funds.
- What are money market mutual funds?
- How do money market mutual funds work?
- Who should invest in money market mutual funds?
- How to invest in money market mutual funds
- How to choose a money market mutual fund
- Are money market funds taxable?
- Alternatives to money market funds
What are money market mutual funds?
A money market mutual fund (or money market fund) is a type of mutual fund that invests solely in short-term, low-risk debt securities such as U.S. Treasury bills, municipal bonds, commercial paper and other cash equivalents.
These funds are known for their short maturity and high liquidity, which makes them a relatively safe place to hold money, like an emergency fund or cash reserves, temporarily.
Money market funds are also an acceptable alternative to traditional savings accounts because, historically, they have provided a higher rate of return.
Types of money market mutual funds
There are three main types of money market funds: government, municipal and prime money funds. Typically, each fund type invests in a specific debt instrument, which in turn determines the fund’s risk level, yields and maturity period.
Government money market funds
Government money funds invest in cash, U.S. government securities and fully collateralized repurchase agreements, which makes them one of the safest money market funds.
It’s also common to find Treasury-only money market funds. These invest the fund’s assets solely in U.S.Treasury securities — T-bills, T-notes and T-bonds. Treasury funds are typically considered the safest option when it comes to government money market funds.
Municipal money market funds
Municipal money market funds, sometimes known as tax-exempt money markets, invest in short-term debt issued by state and local governments. Depending on the type of municipal securities the fund invests in, earnings may be exempt from federal and state income taxes.
These funds are generally a good option for investors who are in a higher tax bracket and want to minimize their tax liabilities.
Prime money market funds
Prime money funds, often called general purpose or standard money market funds, invest in any type of short-term, high-quality debt securities, including certificates of deposit, corporate notes, commercial paper, repurchase agreements, and other debt securities issued by corporations and financial institutions.
Prime money market funds typically offer higher yields than government money funds. However, experts often consider them slightly riskier than government and municipal money market funds.
How do money market mutual funds work?
Much like mutual funds, money market funds provide investors access to a diversified portfolio that’s invested in a specific group of securities and managed by an investment company, such as Fidelity Investments or Vanguard.
Basically, the investment company pools money from multiple investors by selling shares of the fund, and then uses the money to buy money market securities in accordance with the fund’s objectives. This is why they’re often known as pooled investments.
The goal of most money market funds is to maintain a stable net asset value (NAV) of $1 per share along with preserving liquidity and capital. The income generated is then distributed to investors (typically monthly) in the form of dividends.
Who should invest in money market mutual funds
Money market funds are a suitable option if you want to earn a higher return than a traditional savings account while keeping a high level of liquidity.
“[Investors] who may need quick access to cash for emergencies within their investment account can consider investing in money market funds,” says Zaneilia Harris, certified financial planner (CFP) and president of Harris & Harris Wealth Management Group.
According to Harris, these funds are a safe place to hold money that investors may have an immediate need for, such as within 24 hours, or “to hold cash for deployment into other longer-term investments.”
Is it worth it to invest in money market mutual funds?
Money market mutual funds may be worth it if you’re looking for a short-term, low-risk investment and consider liquidity of utmost importance.
If you want to make sure you have easy access to your money at any time, money market funds are a great choice, says Lucas Noble, CFP and owner of Noble Financial.
However, as with most investments, your decision should depend on factors like your financial goals and risk tolerance.
Below are some key features you should consider before investing in money market funds.
Money market mutual funds advantages and disadvantages
|Money market funds advantages||Money market funds disadvantages|
|Because money market funds invest in low-risk debt securities, they are a relatively safe option for those with short-term investment goals.||Money market funds have operating and administrative costs, which are passed to you as an expense ratio. Funds with higher expense ratios can eat into your returns.|
|They are highly liquid, meaning they offer easy access to your money when needed.||They offer lower returns than other types of mutual funds or riskier investments, like bonds and stocks.|
|Money market funds generally offer higher interest rates than traditional savings accounts and money market accounts.||In some cases, the interest rates can be similar to those found on time deposit bank accounts, like certificates of deposit and high-yield savings accounts.|
|They are regulated by the U.S. Securities and Exchange Commission (SEC), which ensures these funds meet specific requirements to operate and that the fund’s portfolio is composed of highly liquid investments.||Money market funds are not insured by the Federal Deposit Insurance Corporation (FDIC).|
How to invest in money market mutual funds
The process for investing in money market funds is much like that of investing in stocks.
- Open a brokerage account: The first step is to open a brokerage account with an online trading platform or an investment app. Most brokers ask for personal information, such as your social security number and annual income.
- Determine how much to invest: Many money market funds have initial investment requirements. Knowing beforehand how much you have available to invest can help you narrow down your options. You should also examine your short-term investment goals, risk tolerance and overall financial circumstances.
- Choose a money market fund: Decide what type of money market fund you want to invest in and compare features like their expense ratio, minimum investment requirements and interest rate. Once you select a mutual fund, place an order.
- Keep track of your investment: Monitor your investment regularly, and make sure it keeps up with your goals. Remember that money market funds are best suited for short-term investment strategies.
How to choose a money market mutual fund
Here are some factors to look at when choosing the best money market funds for your portfolio.
Consider the type of fund
Look for the type of money market mutual fund that better fits your goals and risk tolerance. Some types of money market funds are more risky than others. For instance, municipal and prime funds can have more capital fluctuations than government and Treasury-only money market funds.
Ask yourself questions like: Are you comfortable with market fluctuations? Are you willing to take on a little more risk in exchange for a higher return? Or do you prefer to preserve your principal (original invested amount) by taking on minimal risk?
You should also check the fund’s prospectus or fact sheet, which you can get from the fund company, or your broker or financial advisor. These typically list the fund’s investment objectives, its potential risks, the investment strategy and other important disclosures that can help you decide whether a particular fund aligns with your goals.
Look at the yield
Money market funds use a 7-day yield to give you an idea of a fund’s expected rate of return. This is a standardized measure that can be used to estimate your potential yields based on a 7-day payout.
Similar to the APY of bank accounts, the 7-day yield can be used to compare yields between funds. Naturally, higher yields are preferable to lower ones. However, keep in mind that you should subtract the expense ratio and any other fees to get a more accurate idea of the fund’s yield.
Evaluate the expense ratio and other fees
The expense ratio for money market funds varies widely depending on the type of fund — municipal, government or prime — and the fund’s sponsor. According to research published by the Investment Company Institute, the expenses and fees of money market mutual funds range from 0.06% to over 1.50%.
Bryan Stiger, a CFP® at Betterment, recommends looking for funds with lower expense ratios, especially because “historically, lower-cost money market funds have outperformed higher-cost money market funds.”
An acceptable range, according to Stiger, would be under ten basis points — anything between 0.06% to 0.10%.
“With money market funds you can pay a low expense ratio and still get a very good money market fund,” says Stiger. “Paying more for it doesn't necessarily mean you'll get higher returns. It's probably just gonna eat into your returns.”
You should also check if the fund charges other fees, such as trading fees or mutual fund commissions.
Research minimum investment requirements
Money market funds have different minimum investment requirements. Depending on the type of fund you want to buy into, these can range from no minimum to upwards of $10,000.
Funds investing in a specific group of securities or looking to achieve higher yields will often require higher minimums.
“As you look at yields, the biggest thing you’re going to find to determine what fund you’re going to use is the minimums,” says Noble. "You see a lot of attractive yields, but is the minimum investment a dollar, $3,000 or $250,000? Each institution can set [a minimum] and determine how much they’re going to give you based on that.”
Ultimately, you should look for funds that have the minimums that meet your criteria.
Make sure the fund is SIPC-protected
Make sure that the investment company managing the money market fund is a member of the Securities Investor Protection Corporation (SIPC).
The SIPC is a federally mandated corporation that protects investors against the loss of cash and securities. For your money to be protected, the brokerage firm has to be a SIPC-member. This way if the broker dealer underwent financial troubles, the securities and cash held in your account would be protected up to $500,000.
You should also make sure the fund is by a reputable institution, registered with the Securities and Exchange Commission (SEC).
Are money market funds taxable?
As with most investments, any dividend or interest payments from money market funds are taxable.
Investors in a higher tax bracket may prefer municipal money market funds, which generally invest in municipal securities that are tax exempt on the federal level or other funds with reduced tax rates.
Implementing a tax-loss harvesting strategy to minimize taxes can also be useful, says Harris, who also recommends meeting with your tax professional or a financial planner each year to plan around your taxes.
Alternatives to money market funds
Money market funds are not always the best option. There are other low-risk alternatives that often offer similar interest rates and can be used to safely grow your money over a short term. These include:
High-yield savings accounts
- Accounts typically offer competitive rates, currently upwards 4.00%
- Insured by the FDIC and NCUA
- Some accounts have withdrawal or transfer fees
High-yield savings accounts feature similar rates to some money market funds. These accounts are safer, extremely liquid and can’t drop in value, which is why some experts recommend them as an alternative to money market funds.
“I personally prefer high-yield savings accounts, because the interest rate, especially right now, is higher”, says Pamela Capalad, CFP® and founder of Brunch & Budget in New York City. “And [because] all high-yield savings accounts are FDIC insured”
Another advantage, according to Capalad, is that you don't have to worry about expense ratios or if your money is invested in something you don't understand.
Currently, the best high-yield savings accounts offer rates between 3% to a little over 4.5%.
Certificates of deposit (CD)
- Can be used as a security for loans
- Offer different maturity dates
- Insured by the FDIC and NCUA
- Locks in your money for a set period of time
- Feature early-withdrawal penalties
Certificates of deposit (CD) are somewhat less liquid than money market funds, but a great option if you’re looking for guaranteed returns at a fixed interest rate.
CDs can be a reasonable and safe alternative, especially CDs with a higher interest rate, Noble says.
“If you want a place where you can leave money safe for one or three years, a CD can be a better alternative,” he adds. Unlike the yields of money market funds, which can fluctuate regularly, CD rates are fixed until the maturity date. This can make predicting your returns easier.
You may also consider a no-penalty CD. This type of CD lets you withdraw your money at any time before maturity, albeit for a lower interest rate than traditional CDs. (Check out Best CD Rates for a list of banks offering the highest CD rates right now.)
- Pay a fixed-rate interest
- Exempt from federal income tax
- More risky than money market funds
- Requires basic understanding of the different types of municipal bonds and how they work
Investors willing to take on a bit of more risk may invest in municipal bonds directly. Municipal bonds are generally issued by a state or local government agency and provide a steady fixed-income source exempt from federal tax. Municipal bonds are also relatively conservative and secure investments.
“[Investors] shouldn’t be afraid to explore bonds,” says Noble. “[These] are avenues where people can achieve higher yields, right now, with very little risk. Municipal bonds are a great example of a relatively safe place to put money, where the interest is guaranteed and you’re currently getting higher yields than a money market.”
Ultimately, this decision should correspond with your willingness to take on some additional risk. Bryan Stiger, for instance, says bonds may not be an alternative if you’re an ultra conservative investor who doesn't want to see any fluctuations in your principal.
Money Market Mutual Funds FAQs
Is a money market fund better than a savings account?
Money market funds are an alternative to traditional savings accounts. In general, money market funds offer low risk and high liquidity, ideal for investors who want a quick and cost-effective way to earn a small profit.
However, money market funds feature different costs, which savings accounts typically don't have. Unlike money market funds, savings accounts are also insured by the FDIC, which can be valuable in case of a bank collapse.
Are there any risks involved in money market funds accounts?
No investment is risk-free, and that applies to money market mutual funds as well. Despite money market funds being less volatile than many other investments, changes in interest rates can cause fluctuations in the fund's value and your principal.
Money market funds also face credit risk, which is the likelihood of an investment issuer defaulting or failing to repay on securities. Although the risk is usually minimal, it can force fund managers to sell at a loss, affecting the pricing of securities and the fund's value.
Are money market mutual funds FDIC-insured?
No, money market mutual funds are an investment product and, as such, they're not insured by the FDIC or NCUA. However, investment companies should be a member of the Securities Investor Protection Corporation (SIPC), a federally mandated corporation that protects investors from the loss of cash and securities up to $500,000 in case of a brokerage firm liquidation.
Summary of How to invest in Money Market Mutual Funds
- Money market mutual funds are a relatively low-risk investment that invest in short-term debt securities, including U.S. Treasury bills, municipal bonds, commercial paper and other cash equivalents.
- Money market funds are generally considered a safe place to hold money you may need immediately, like an emergency fund or cash reserves.
- When choosing a money market fund, consider the type of fund, minimum investment requirements, the expense ratio and average yield.
- Depending on your goals and time frame, you may consider similar alternatives, like a high-yield savings account or certificates of deposit.
- Money market funds are not FDIC-insured. However, brokers and dealers should be members of the Securities Investor Protection Corporation (SIPC).