What are money market funds?

  • Money Market Funds
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A money market mutual fund is a type of fixed income mutual fund that invests in debt securities characterized by their short maturities and minimal credit risk. Money market mutual funds are among the lowest-volatility types of investments. Income generated by a money market fund can be either taxable or tax-exempt, depending on the types of securities in which the fund invests.

Regulations from the U.S. Securities and Exchange Commission (SEC) define three categories of money market funds based on investments of the fund – government, prime and municipal. SEC rules further classify prime and municipal funds as either retail or institutional based on investors in the fund.

Categories of money market mutual funds based on investments

The types of debt securities held by money market mutual funds are required by federal regulation to be very short in maturity and high in credit quality. All money market funds comply with industry-standard regulatory requirements regarding the quality, maturity, liquidity, and diversification of the fund’s investments. Investments can include short-term U.S. Treasury securities, federal agency notes, Eurodollar deposits, repurchase agreements, certificates of deposit, corporate commercial paper, and obligations of states, cities, or other types of municipal agencies—depending on the focus of the fund.

Fund Type Primary Types of Instruments Held
Government including U.S. Treasury
Treasury only Normally at least 99.5% of the fund’s total assets are invested in cash and U.S. Treasury securities -- including at least 80% of the fund’s assets in U.S. Treasury securities.
Treasury Normally at least 99.5% of the fund’s total assets are invested in cash, U.S. Treasury securities and/or repurchase agreements * collateralized by U.S. Treasury securities – including at least 80% of the fund’s assets in U.S. Treasury securities and repurchase agreements for those securities.
Government Normally at least 99.5% of the fund’s total assets are invested in cash, U.S. government securities and/or repurchase agreements that are collateralized fully (i.e., collateralized by cash or government securities) – including at least 80% in U.S. government securities and repurchase agreements for those securities. Certain issuers of U.S. government securities (e.g., “Government Sponsored Enterprises” such as Fannie Mae, Freddie Mac and the Federal Home Loan Banks) are sponsored or chartered by Congress, but their securities are neither issued by nor guaranteed by the U.S. Treasury.
Prime (also known as general purpose)
  Assets are invested in any eligible U.S. dollar-denominated money market instruments as defined by applicable U.S. Securities and Exchange Commission regulations (Rule 2a-7 of the Investment Company Act of 1940), including all types listed above as well as commercial paper, certificates of deposit, corporate notes and other private instruments from domestic and foreign issuers, as well as repurchase and potentially reverse repurchase agreements.
Municipal (sometimes known as tax-exempt)
National municipal Normally at least 80% of the fund’s assets are invested in municipal securities whose interest is exempt from federal income tax.
State municipal Normally at least 80% of the fund’s assets are invested in municipal securities whose interest is exempt from federal and state personal income taxes.

* A repurchase agreement is an agreement to buy a security at one price and a simultaneous agreement to sell it back at an agreed-upon price.

Classification of prime and municipal money market mutual funds based on investors

Retail prime and retail municipal money market mutual funds have policies and procedures reasonably designed to limit all beneficial owners to “natural persons” (i.e., individual investors). These funds may continue to seek to maintain a stable $1.00 net asset value (NAV), but are subject to potential liquidity fees and redemption gates (i.e., the fund may impose a fee upon the sale of your shares, or may temporarily suspend your ability to sell shares, if the fund’s liquidity falls below required minimums because of market conditions or other factors).

Institutional prime and institutional municipal money market mutual funds are funds that do not qualify as retail funds – i.e., they may be held by institutional investors. These funds are subject to potential liquidity fees and redemption gates, and will price and transact at a floating NAV (meaning that the NAV will be priced to four decimal places, e.g. $1.0000, and will experience fluctuations from time to time).

Government money market mutual funds, including U.S. Treasury funds, are available to both retail and institutional investors, and are not subject to potential liquidity fees, redemption gates, or a floating NAV.

Investors who might consider money market funds

Money market funds may be appropriate for customers who:

  • Have an investment goal with a short time horizon.
  • Have a low tolerance for volatility, or are looking to diversify with a more conservative investment.
  • Need the investment to be extremely liquid.

While the returns on money market funds are generally not as high as those of other types of fixed income funds, such as bond funds, they do seek to provide stability, and can therefore play an important role in your portfolio. Investors can use money market funds in a few ways:

  • To offset the typically greater volatility of bond and equity investments.
  • As short-duration investments for assets that may be needed in the near term (such as an emergency fund).
  • As a holding place for assets while waiting for other investment opportunities to arise (such as in the core position for your brokerage account).

Evaluating a money market fund

A money market fund is a type of fixed income mutual fund with very stringent maturity, credit quality, diversification and liquidity requirements intended to help it achieve its goals of principal preservation and daily access for investors. Customers should determine when picking a money market fund that its characteristics align with their investment objectives and strategy.

  • The objective for many money market funds is typically to provide current income consistent with principal preservation.
  • U.S. Treasury and government money market funds potentially can offer a lower credit risk and return profile than prime money market funds.
  • Municipal money market funds may be appropriate for non-retirement accounts that are not already tax-shielded.

Advantages of money market funds

  • Stability
    Money market mutual funds are considered to be one of the least volatile types of mutual fund investments.
  • Liquidity
    It’s easy to settle your brokerage account trades in other investments, or retrieve funds from a money market mutual fund—generally assets are available by the next business day.
  • Security
    The funds are required by federal regulations to invest in short-maturity, low-risk investments, making them less prone to market fluctuations than many other types of investments.
  • Short duration
    Because the duration of money market mutual funds is so short – at maximum a few months -- they are typically subject to less interest rate risk than longer-maturing bond fund investments.
  • Diversification
    Money market mutual funds tend to hold many different securities, with limited exposure outside U.S. Treasury funds to any single issuer.
  • Potential tax advantages
    Some money market funds invest in securities whose interest payments are typically exempt from federal, and in some cases, state income taxes. These funds can be a potential source of stable, tax-efficient income.

Risks of money market funds

  • Credit risk
    Unlike typical bank certificates of deposit (CDs) or savings accounts, money market mutual funds are not insured by the Federal Deposit Insurance Corporate (FDIC). Although money market mutual funds invest in high-quality securities and seek to preserve the value of your investment, there is the risk that you could lose money, and there is no guarantee that you will receive $1 per share when you redeem your shares.
  • Inflation risk
    Because of the safety and short-term nature of the underlying investments, money market mutual fund returns tend to be lower than those of more volatile investments such as typical stock and bond mutual funds, creating the risk that the rate of return may not keep pace with inflation.

Prime money market funds:

  • Foreign exposure
    Entities located in foreign countries can be affected by adverse political, regulatory, market, or economic developments in those countries
  • Financial services exposure
    Changes in government regulation and interest rates and economic downturns can have a significant negative effect on issuers in the financial services sector, including the price of their securities or their ability to meet their payment obligations.

All prime and municipal money market funds:

  • Liquidity risk
    The fund may impose a fee upon the sale of your shares, or may temporarily suspend your ability to sell shares, if the fund’s liquidity falls below required minimums because of market conditions or other factors.

Institutional prime and institutional municipal money market funds:

  • Price risk
    Because the share price of the fund will fluctuate, when you sell your shares they may be worth more or less than what you originally paid for them.

Frequently asked questions

Why can yields on money market mutual funds be very low?

Money market mutual funds own a well-diversified pool of high quality, short-dated, interest-paying securities, and pass along the income earned on those securities (after fees) to the funds’ shareholders. When the yields on the securities in which money market mutual funds invest are quite low, the yields that the funds are passing along to their shareholders are also quite low. The interest rate policy of the Federal Reserve (the Fed) is a key driver for money market rates.

How short is “short term” for the securities in which money market mutual funds can invest?

The rules that govern money market mutual funds permit the funds to buy only securities that mature in 397 days or less. At least 30% of the fund’s total assets must be invested in Weekly Liquid Assets, which can consist of cash, direct obligations of the U.S. government such as U.S. Treasury bills, certain other U.S. government agency debt that is issued at a discount and matures within 60 days or less, or securities that will mature or are payable within five business days. For taxable funds, at least 10% of the fund’s total assets must be invested in Daily Liquid Assets, which can consist of cash, direct obligations of the U.S. government, or securities that will mature or are payable within one business day. The remaining investments can be in longer-term issues, provided the overall weighted average maturity of the fund is 60 days or less.

Why doesn’t the government offer insurance on money market mutual funds?

The U.S. government does not offer insurance on any type of mutual fund. Money market mutual funds, like bond and stock mutual funds, are investments, and, as such, are not guaranteed. It is important that investors understand that.

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