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Money Market Funds 101

Money market funds are considered to be one of the lowest-risk options in the mutual fund world, but they also offer the lowest expected returns. Here is everything you need to know about investing in money market funds:

Stable share price. Money market funds are like typical mutual funds, except that their share prices are designed to remain stable at exactly $1.00. The funds achieve this by investing in ultra short-term securities, often with maturities of a week or less. Typically, the funds invest in the short-term debt of the U.S. government or the highest-rated corporations .

The stable share prices makes money market funds the least risky option in the mutual fund world, and one that investors typically use to shelter money that they need to keep safe.

Money market funds aren’t entirely risk free. While money market funds are the lowest risk mutual fund, they are not entirely risk-free. On rare occasions, the funds have been known to “break the buck,” or suffer a decline in the $1 share price. This has only happened a few times, and fund companies typically devote their own funds to making investors whole. However, it’s important to keep in mind that there is no FDIC insurance or government guarantee with mutual funds. Instead, investors need to trust that the fund company will support the $1 share price if anything happens to the underlying securities in the fund.

Learn more about these issues in my article, How Risky are Money Market Funds?

Low yields. A general rule thumb in investing is that the higher the risk, the higher the potential return. Since money market funds are on the low end of the risk spectrum, they typically pay very little in the way of yield – particularly in today’s low-rate environment.. In 2012, for instance, most money market funds finished with returns of 0.01% to 0.04%. As a result, investors in the funds received a return well below the rate of inflation. meaning that they lost money on a “real ,” or after-inflation, basis.

Highly liquid. Money market funds are very “liquid,” which means that the money is easily accessible. Many money market funds also offer checking, which provides people with an alternative to checking accounts.

Can be used as a “parking place”. Money market funds won’t make anyone rich, but they serve a key purpose – providing investors with a safe vehicle to hold money for a short period of time. When investors sell a mutual fund or make a transaction in a brokerage account, the proceeds are typically reinvested in money market funds. Also, the funds provide investors with a place to hold money while waiting to make a specific payment, such as college tuition, in the immediate future. Money market funds are appropriate for this need, since the stable share price means that investors don’t have to worry about a loss of principal for money that’s needed in the very short term.

Disclaimer. The information on this site is provided for discussion purposes only, and should not be construed as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities. Always consult an investment advisor and tax professional before you invest.