Since interest rates have risen in the past two years, money market funds have become more appealing to investors. Money market funds, which are invested in short-term, safe securities, are mutual funds that closely track the Federal Reserve’s benchmark rate. With interest rates at a more than 20-year high, some money market funds offer yields of around 5%.
Before you invest, let’s break down what you need to know to determine whether they’re right for you.
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Open AccountHow money market funds work
Money market mutual funds have been around since the 1970s, but there’s been a resurgence of interest in them due to the Silicon Valley Bank failure last year and the Fed’s rate hikes. These funds are offered by brokerages and are invested in low-risk, short-term assets, such as Treasury securities, corporate and municipal bonds, and certificates of deposit (CDs). Interest is typically paid out monthly.
Yields on money market funds tend to fluctuate with changes in the federal funds rate. They’re very liquid investments, making them a good place to park money you may need to access again quickly.
Are money market funds safe?
Although money market funds aren’t covered by Federal Deposit Insurance Corp. (FDIC) insurance because they’re mutual funds, not bank accounts, they’re still safe. (Note that money market funds are different than money market accounts, which are a type of deposit account offered by banks and credit unions.)
Why? Money market funds must have a net asset value (NAV) of $1 per share.
Insight from Sophoan Prak, Certified Financial Planner (CFP) and Financial Advisor at Vanguard
“Money market funds maintain a net asset value or closing price of [a] dollar per share. That’s the whole goal of the money market fund. You’re not going to really see any price fluctuation and that’s what creates the safety feature. There could be, in history, money market funds that have broken the buck, but that’s very rare.”
In other words, money market funds aren’t volatile investments, which means you’re unlikely to lose money by investing.
If you do invest in a money market fund, make sure to opt for a brokerage that has Securities Investor Protection Corporation (SIPC) insurance. SIPC insurance won’t protect you if the money market fund breaks the buck, but it will protect investments up to $500,000 in the event of a brokerage failure.
Types of money market funds
There are a few different types of money market funds; some invest in corporate debt, others in government-issued bonds, and some in both.
- Municipal: these funds are exempt from federal tax because they’re invested in municipal bonds, which are debt issued by cities and states. Generally, they offer lower yields than other types of money market funds.
- Government: these funds are invested in Treasurys and other federal government securities.
- Prime: these funds are invested in government securities, CDs, corporate debt, and more.
Who are money market funds right for?
Anyone can invest in a money market fund, but it’s best for money you plan to use in the near future, such as a vacation you want to take a year from now.
“Money market [funds] are really intended for short-term needs, such as an emergency fund,” says Prak. “If you actually need the money to pay your bills or even if you need the money within the next one or two years, that’s when money market funds would be an appropriate investment to use as an alternative to keeping your money at a local bank or a savings account.”
While some money market funds boast yields well above 4%, you don’t want to put too much money into them, especially for long-term investing. Money market yields usually don’t outpace inflation. And with the Fed planning to cut rates later this year, yields will likely decline.
Pros and cons of money market funds
Money market mutual funds carry great benefits for many investors, but they’re not going to be the best fit for everyone. Here are some key things to remember:
Pros
- Principal protection. You can protect your initial investment and possibly earn a decent return, depending on interest rates.
- Some offer tax advantages. By investing in municipal money market funds, you can avoid paying federal tax on your investment.
- Liquidity. You can typically access your cash within a few business days.
Cons
- Yield may not beat inflation. If you want an investment that outpaces inflation, try stocks and bonds instead of money market funds.
- Lack of insurance. You won’t receive FDIC or National Credit Union Administration (NCUA) insurance with a money market mutual fund.
The takeaway
Money market mutual funds can be a solid option if you want to earn a decent yield but still want to access your cash whenever you need it. This low-risk investment probably isn’t the best place to stash your money in the long run, but it can be a good place to store an emergency fund or savings you may need to tap immediately.
