Money market funds are open-ended mutual funds that invest in short-term debt securities, such as U.S. Treasury Bills and commercial paper. Usually, money market funds seek a stable net asset value (NAV) of $1.00 per share that’s maintained by paying a daily dividend to shareholders equal to its net income. Breaking the buck, or moving below $1.00, is extremely rare.
Money market funds shouldn’t be confused with money market accounts, which are bank or credit union accounts similar to a savings account. Unlike money market accounts, money market funds are not insured by the FDIC or NCUA and must be purchased through an investment broker. Same-day settlement is common for most funds, but the cash isn’t instantly available.
Let’s take a closer look at the benefits that money market funds offer over alternative investments.
Money market funds are required to invest in diversified, high-quality investments that mature in less than 13 months under Rule 2a-7 of the SEC Investment Company Act of 1940. In addition to asset class diversification, prime money market funds may invest in private debt instruments from foreign issuers to provide geographic diversification. Check out the charts shown below to see the geographic diversification of government and treasury money market funds by the country of counterparties, as well as the percentages of weekly liquid assets.
Money market funds may hold different securities depending on their type.
Government – Government money market funds hold 99.5% cash, U.S. government securities or repurchase agreements that are fully collateralized, making them the safest option.
Prime – Prime money market funds invest in any eligible U.S. dollar-denominated money market instruments, including certificates of deposit, commercial paper, and foreign debt.
Municipal – Municipal money market funds typically hold 80% municipal securities that are exempt from federal and/or state taxes.
Check out the different types of money market funds here
2. Better Yields Than Deposit Accounts
Many retail investor brokerage accounts invest any idle cash in an account into money market funds because the interest rate is higher than otherwise possible. In addition, some money market funds invest in securities whose interest payments are exempt from federal and some state income taxes, which can provide a source of stable and tax-efficient income. The chart below shows the average seven-day net yields for various types of money market funds. It’s worth noting that institutional yields are higher than retail yields and prime funds tend to yield more than government or treasury money market funds.
As a specific example, the Vanguard Prime Money Market Fund (VMMXX) has a $3,000 minimum investment and a 0.16% expense ratio. The fund yielded 2.35% over the past year (up to 7/31/2019), compared to a 1.90% interest rate for a competitive bank deposit, by holding primarily Yankee/Foreign debt, U.S. government debt, and certificates of deposit.
3. Superior for Some Cash Management
Money market funds must have a weighted average maturity of 60 days or less and invest no more than five percent in any single issuer with the exception of government securities and repurchase agreements. These rules are designed to ensure that money market funds are extremely liquid in the event of a financial crisis that causes a high number of withdrawals.
In addition to their liquidity, money market funds are not subject to market timing restrictions, which means they can be bought or sold at any time. Many brokerage accounts also provide check writing privileges and offer same-day settlement, which means that the cash is easily accessible for withdrawal or use in making other investments.
4. Low Initial Investment and Expense Ratio
Many money market funds have low minimum requirements compared to other mutual funds. In some cases, money market funds have no minimum investment or transaction fees to buy or sell. This makes them an ideal alternative to holding cash within a brokerage account since it provides some kind of yield on the money over the short term. However, investors should also be cognizant of the expense ratios associated with these funds.
Some money market funds with low expenses include:
Vanguard Federal Money Market Investor Fund (VMFXX)
Vanguard Municipal Money Market Investor Fund (VMSXX)
Vanguard Treasury Money Market Investor Fund (VUSXX)
These funds have a minimum investment of $3,000 in a qualified IRA, but the expense ratio ranges from 0.09% to 0.18%, which is much lower than the respective category averages.
By comparison, the Schwab Government Money Fund (SNVXX) has no minimums or transaction fees, but charges a net expense ratio of 0.32%, making it more expensive to own.
Money market funds are fixed income mutual funds that invest in debt securities with short maturities and minimal credit risk. These characteristics make them attractive to investors looking for a place to park idle cash until an investment opportunity arises or those looking for an alternative to a conventional bank deposit account.