Mutual Funds vs. Money Market Funds: An Overview
Mutual funds and money market funds are two options for investors, whether the objective is a short-term financial goal or long-term wealth. The most important difference between the two is the degree of risk that the investor takes on.
A mutual fund invests money in a selection of securities, mainly stocks and bonds. Thousands of funds are available to investors, and they range from funds that buy highly speculative stocks to funds that are devoted to blue-chip stocks, high-quality bonds, or some of each. In any case, the investor accepts a degree of risk of lost principal. On the other hand, a money market fund is a type of mutual fund that invests only in ultra-safe investments, such as Treasury securities that are guaranteed by the U.S. government. Only a disaster of unprecedented proportions could jeopardize your principal. However, with the low risk comes a lower reward.
Key Takeaways
- Mutual funds and money market funds are both pools of money invested by professional money managers.
- There are thousands of mutual funds available, and their risks vary widely from blue-chip conservative to highly speculative.
- A money market fund invests only in low-risk short-term debt such as Treasury bills.
- Money market funds value the safety of principal over the chance of high profits.
Mutual Funds
A mutual fund is a pooled fund. The contributions are combined to enable the fund managers to give each investor exposure to a variety of investments. Their investors can accurately say that they have money invested in, for example, oil, gold, and banking. That's a breadth that most individual investors would not be able to mimic.
A mutual fund may include investments in company stocks, corporate bonds, municipal bond issues, or government treasuries. Many funds invest in some combination of these financial instruments.
An investor considering a fund should look at the expense ratio, which is the percentage of assets deducted yearly for fees.
Mutual funds are professionally managed. That comes at a cost to the investor in fees that are deducted from the account. The fees vary widely among investment companies. They also vary among funds, with higher fees generally associated with the most actively-managed funds. In addition, companies charge fees for advertising, administration, and other costs.
An investor considering a fund should look at the expense ratio. That indicates the percentage of an investor's assets that are deducted yearly for all fees.
In any case, the goal of a mutual fund is to outperform the market through active management investment strategies. "The market" in this case varies, with each fund aiming at a relevant benchmark. A technology-heavy fund, for example, may seek to outperform the NASDAQ Index or the S&P North American Technology Sector Index. When the investor gets the fund's financial report, its performance will be compared to that index.
Money Market Funds
Money market funds focus squarely on preserving principal and achieve that by investing only in short-term Treasury securities and other low-risk liquid investments. All of their investments are in interest-paying debt, but it's low-risk debt.
Money market accounts aim to hold the net asset value of each share at $1 while creating a steady, though relatively low, return in interest for investors.
Expense ratios are relatively low for money market accountsbecause they are not as actively managed as stock mutual funds. The sales loads required to purchase money market funds also are low or nonexistent.
Active investors often use money market funds as a holding account for money that is soon to be invested and for money generated from the sale of other securities.
