Investing > Complete Guide to Money Market Funds

Complete Guide to Money Market Funds

These assets come with lower risk and higher liquidity—but usually offer very low returns.

Reviewed by
Updated January 05, 2024

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What do all great pirates have in common with successful financial investors? 🏴‍☠️

With the difference being the legality of their respective enterprises, the government does all in its power to come after and snag the piece of their hard-earned coin—and to preserve their treasure, both of them must know how to skillfully navigate their respective rising tides. 🌊

While the waves of inflation may not be as dangerous as sea storms, they make the seas of financial investments just as unpredictable and increasingly difficult to navigate. Inflation in some parts of U.S. in January of 2022 raised the overall prices by a whopping 9% margin. Arguably it’s equally stressful as having to deal with scurvy, but in this case, citruses won’t help you feel better.

Burying your hard-earned treasure and stashing it away won’t keep it safe from this financial plague either, not by a longshot. So how does one navigate the ship to a safe harbor while keeping the risk and the costs at a minimum? 

The answer to this may be to prolong your journey and sail on further—investing your hard-earned funds into even low-income assets will prevent the leakage caused by inflation and essentially save some of your money until a more opportune chance for investment arises on the horizon.

Money market funds are one of the alternatives to keeping your money in a savings account and burying your treasure away. Because of their liquidity and the lower risk they offer, they may seem like a good temporary destination for you to stash your hard-earned gold and maybe earn an extra penny or two in the process.

So before deciding on setting your course for this financial island let’s take a closer look at all the potential benefits and hindrances you may encounter along the way.

What you’ll learn
  • What's a Money Market Fund?
  • How Money Market Funds Operate
  • Types of Money Market Funds
  • How to Invest in Market Funds
  • Why Invest in Money Market Funds?
  • Money Market Fund Alternatives
  • What to Consider Before Investing?
  • Conclusion
  • FAQs
  • Get Started with a Stock Broker

A Brief History of Money Market Funds 📖

As eager as we may be to dive weigh our anchor and reach it, to understand our potential destination a bit better, it does pay to know more about the past behind it and how it all started.

In 1971. Bruce R. Bent and Henry B. R. Brown introduced the Reserve Primary Fund to the world. This fund that invested in highly liquid securities, was offered as a new alternative to bank accounts for investors who wanted to preserve their funds and earn small return rates along the way. The banks were at the time under the limitation of Regulation Q, which prohibited transaction accounts from paying interest and capped the interest rate on other types of accounts at 5.25%. 

The alternative Bruce and Henry offered had no such limitations and with the inflation threshold passing 5% in 1969, people were essentially losing money by keeping it in a savings account. Many transferred the funds over to the Reserve Primary Fund, which paid well over the 5.25% rate the banks were offering at the moment.

An avalanche of capital departed the banking industry, establishing the money funds as a new intermediary capital. More money market funds such as this one were set up shortly after that, and this led to the popularization of mutual funds in general, which were not that prominent at the time.

What’s a Money Market Fund? 👇

Like their original counterparts, money market funds nowadays contain high-quality short-term fixed income securities, cash equivalents, and cash. They invest in these assets and seek to limit their exposure to credit, market, and liquidity risks and other scurvies of the financial world while paying varying interest income to investors such as yourself along the way.

What they also bring to the table is a diversity of financial portfolio and high daily liquidity, which is why they are a potentially great temporary harbor for your funds. They are professionally organized with the goal of sustaining high stable asset value, in the best monetary interest of the investors. 

They carry a relatively low level of risk, but correspondingly lower returns than that of equity security as well. On top of that, they have no guarantee of principal as they are sponsored by an investment fund company, which means that the return rate they offer is not as stable.

Keep in mind that, although they bear a similar name, they are not to be confused with money market accounts. (MMA) Money market accounts have a guarantee of principal and these are the types of interest-earning accounts offered by the financial institution. 

They are insured by the Federal Deposit Insurance Corporation (FDIC), but they have limited transaction privileges and hence significantly lower liquidity, so mistaking them for MMFs may yield an entirely different result and true to their violent abbreviation knock your funds out for an extended period of time

How Money Market Funds Operate 🏗

Knowing what the money market funds are surely is useful, but understanding how they function is the other, equally important half of our voyage. 

Money market funds are mutual funds comprised of the aforementioned highly liquid, yet at the same time high-quality securities. By investing in such a fund you will essentially be buying shares or redeemable units of a rather diverse financial portfolio. 

Speaking in pirate terms, you will be spending your gold coins to obtain a portion of the chest that consists of coins, jewels, and other highly coveted treasures of equal value. So why would you do such a thing you wonder? 🤨

While money market funds do indeed operate as typical mutual funds, there is one key difference as well. They aim to maintain the net asset value (NAV) of $1 per share. However, as they invest in debt securities, they produce a regular stream of income into the fund. 

Every earning that exceeds NAV that gets generated along the way is distributed to investors in form of regular payment, and your treasure thus generates a relatively small but steady flow of coins from the fund manager.

While the money market funds and their portfolios are professionally managed in order to maximize their value, they are in addition to that regulated by the Security and Exchange Commission (SEC). The latest amendment to the rules was proposed in December 2021. The rules set in place dictate the quality, maturity, and diversity of investments. 

Money fund primarily buys the highest-rated bonds, which mature in under 13 months. Additionally, the portfolio of the fund has to maintain a weight average maturity (WAM) of 60 days or less and cannot invest more than 5% in any issuer, with the government securities and repurchase agreements being the exception to this rule.  

What Do Money Market Funds Invest In? 🤔

So you may be wondering what is this “highly coveted treasure” you will be investing your hard-earned coin exactly via fund manager—or to put it more bluntly where does your money go in this case?

As we mentioned before, MMF is more of a collection of assets rather than a singular currency. Therefore it would be difficult to single out specific security as the most important one but here are some more common securities that can be found in the foundations of money market funds:

Types of money market investmentsWhat they are
Bankers acceptanceA form of payment guaranteed by a bank that works as a bank-issued post-dated check of sorts. Unlike post-dated checks, these securities are tradeable in secondary markets at a discount.
Certificates of depositA short-term bank-issued certificate of savings that pays a fixed interest rate. These are FDIC insured in case of institution’s bankruptcy.
Commercial paperA short-term company-issued, unsecured debt asset which yields its face value at maturity, reflecting current interest rates. Average maturity ranges around 30 days
Repurchase agreementA very short-term agreement where the government sells securities and buys them at a higher price later. Maturity with a tenor of overnight ranges up to 48 hours.
U.S. Treasury securitiesShort-term government-issued securities, usually notes and bills, tradeable on the secondary market at a discount price.

Most, if not all of these securities that MMF usually trades with are debt type of securities. These securities usually yield scheduled interest rate payments until their maturity date when the loan needs to be paid in full, and these interest rates essentially provide the flow of cash into the money market fund.

Because of this, regular payments that MMFs provide are very dependent on the market situation and therefore have to be tended to by a fund manager on a regular basis, and their portfolio adjusts in accordance with the market situation as well.

For instance, with markets increasingly focusing on inflation which started back in November of 2021, the government started selling some of the special securities such as repurchase agreements at an increased rate, which made them attractive to money market fund managers.

Different Types of Money Market Funds 🗃

Although we have established some investment patterns, there are many different types of debt-based securities that money market funds invest in. But if you are looking to invest in the fund yourself, knowing how different money market funds work is important.

Different types of money market funds deal with different types and groups of securities we’ve covered, and each one is an island of sorts by itself, with its very own pros and cons.

Some money market funds are available to individual retail investors, while others require a high minimum investment and are only usable by institutional investors.

With the difference being the returns they may provide, their overall stability, or whether they are taxable or not, there are several types of money market funds you can find out there on the market, but three main ones—government, prime, and tax-exempt money market funds.

Government Money Market Funds 🏦

These types of money market funds, as their name suggests, primarily invest in securities such as U.S. Treasury securities, government-backed repurchase agreements, and other types of government securities insured by the FDIC.

99.5% of the fund’s assets are invested in cash and these securities and at least 80% of its total assets are invested in the aforementioned U.S treasuries and repo agreements that are completely collateralized by government securities or cash.

Government MMFs, including U.S. Treasury funds, are available to both institutional and retail investors. They do not have liquidity fees, redemption gates, or soaring NAV that some funds do, and this is one of the potential advantages. These funds usually attract somewhat more conservative investors who seek highly liquid assets with credit risk at its minimum.

But as far as earning money goes, the average yearly returns in 2021 you were getting out of these ranged from %0.00 to %0.03, so they shouldn’t really be considered a long-term harbor for your financial watercraft, not unless you like throwing your hard-earned treasure overboard.

Prime Money Market Funds 🌟

Prime money market funds, also known as general purpose funds, mainly consist of short-term debt securities issued by corporations, U.S. government agencies, government-sponsored enterprises (GSE). 

They also invest in commercial papers of other, non-Treasury securities such as certificates of deposit, corporate notes, and bankers’ acceptances. Some of these assets are not insured, as they are issued by corporations the same way the stocks are, but in terms of risk, they are still considered a safe investment. 💸

Retail prime MMFs are designed to be accessible only by individual investors and have limitations set in place to ensure this. They seek to maintain a stable NAV of $1 per share, but they could potentially have liquidity fees and redemption gates.

What this means in practice is that should the fund’s liquidity fall below the minimum threshold due to market conditions and any other underlying factors, your ability to sell shares may be temporarily suspended or you might have to pay a fee should you choose to sell at the time. 📊

Institutional prime money market funds have many of the same rulings in place, but they can be held by institutional investors as well, not just the retail ones. The difference being they transact at a floating NAV, priced to 4 decimal places ($1.0000) which can fluctuate over time.

While the yearly returns are admittedly better than for their government counterparts, a rate of 0.2 to 0.3% still seems meager compared to an average yearly return of stocks, should you know when to trade stocks, of around 10%. So if you are looking solely to increase your treasure, you might want to avoid casting an anchor on this pier altogether.

Tax-Exempt Money Market Funds 📃

As their name implies, these MMFs invest mainly in securities that produce tax-free interest income on some level. Municipal bonds are usually their main ingredient and this is why they are also known as municipal money market funds.

Their income is free from federal taxes and also, depending on the exact securities they invest in, these MMFs could be exempt from state income taxes as well. In case the investors buy municipal bonds issued by their home state/municipality, they are free from local tax enforcers as a bonus. 

Thus, we can distinguish between the two subgroups of tax-exempt MMFs—national ones, where at least 80% of the securities are invested in free-of-federal-tax assets, and state ones, same 80% but exempt from federal and local personal income taxes.

Just like with prime money market funds, there are retail ones and institutional ones available on the market, and the same potential liquidity fees or redemption gates may occur. But in terms of general risk, as they are FDIC insured they fare a bit better overall in terms of risk, which is still relatively low.

Even with the returns exempt from taxes, however, in terms of pure capital gain, these securities do not drastically eclipse the others on this list, hovering around 0.2% to 0.35% average return rate. So, again, if you think you will be discovering the buried treasure laying around this island, it might not be the real deal for you, but they may help you smuggle away a couple of tax-free gold coins for sure.

How to Invest in Market Funds 👷‍♂️

So you have decided that you want to test the waters of money market funds and potentially invest some of your well-kept financial loot their way? Well every journey begins with a single step, and in this case, there are several that you need to take to ensure smooth and as risk-free as possible sailing:

Get Familiar With the Waves 🌊

At the very start of this journey, you might want to ask yourself why do you want to begin with it at all. Knowing for what purpose you would need these assets and how much of them you need for your purposes will help you determine the further course of your voyage.

Experienced investors, for instance, usually have an abundance of safe low-yielding assets as a part of their financial portfolio and are always prepared for any potential storms approaching the horizon. With the possibility of a stock-market bubble looming at the end of 2021, owning such assets could help you offset the potential losses.

Younger sailors in the financial waters, on the other hand, usually prefer having riskier portfolios with a higher upside. With securities that have greater potential, comes greater risk but the margin of profit is significantly higher, and so is the chance for a total shipwreck and your treasure to be lost forever at sea. The stocks however are fighting back the tides of inflation in 2022. and some are even prospering.

Understanding the end goal of your voyage as well as the financial waves that surround you will help you navigate it more comfortably to determine if money market funds will help you reach your destination and desired results.

Choose a Reliable Crew 🏆

When you determine that they are the right type of investment for you, especially if you are on the side of less experienced sailors, you still might need help allocating your treasure towards the desired money market funds. 

Choosing the right stock brokers for you is just like choosing the right navigators for your financial ship, and in the vast sea of brokers, you would need to find the one that supports MMF investing. Some of the top stock brokerages will help you with this for a minor to no commission fee and ensure that you get the treasure you want. 💰

If you are more experienced with the matter and should you desire to steer this ship yourself and execute the trades on your own, there are some easy to use stock trading apps that will help you allocate your coin for, again, small or no-fee commissions. 

The crew you have gathered this way also has incredibly low chances of robbing you blind and leaving you for dead on a deserted island somewhere along the way. In addition to that, it will help you maximize potential returns or offset the losses of your MMF assets.

Be Mindful of the Open Sea 💡

You may have your precious MMFs safely stored in the chest and you may be thinking that it is secured. Well, not quite as the inflation Kraken still might reach with its evergrowing tentacles for your treasure box if you hold onto it for too long.

Monitoring and reforming your financial portfolio in accordance with the current market situation is important. Not only that by being mindful of it you may prevent your potential losses, but it could also lead you to additional profits as well.

Let’s say a bear market swings, and you own a lot of MMFs at the moment that remained stable throughout the crash of a stock market. Given how the Covid-19 pandemic swung the market in February of 2020, scenarios such as this one ain’t difficult to imagine. 🐻

Amidst the shipwreck of the stock exchange at that moment, you could potentially sell your money market fund assets that kept their value, at a decent price. You could use that capital to swoop down on the underpriced stock market, leaving you potentially with a decent margin of profit once their prices return to normal.

The stock market may be a cruel mistress, so taking every possible advantage of your investment portfolio and allocating your assets properly may help you not only survive the potential calamity—it may also help you collect the profit that the financial sea washes ashore after the storm.

Why Invest in Money Market Funds 🧐

So why exactly should one invest in MMF assets and what’s their purpose in the financial portfolio nowadays? Is it worth your coin in the face of rising inflation?

When compared to similar investment alternatives such as short-term bond funds, bank money market accounts, and certificates of deposit, MMFs invest in a greater assortment of financial assets and aim for greater returns. 🎯

But these returns are still very minute compared to equities such as stocks, and most likely will not outpace inflation. For instance in December of 2020 when the inflation was at 1.36% which was lower than the 20-year average rate of 2.1%, average returns on money market funds was merely 0.36%. 

You are more likely to get rich by digging out an actual hidden treasure than from these rates, given how inflation reached 7% in December of 2021, a number unseen in decades.

Their primary purpose is to provide a safe option for investors in form of sheltered and immensely liquid, cash-equivalent debt securities while they require smaller investment amounts—in their essence, they are low-risk, low-return properties.

Although the NAV of $1 per share is not technically guaranteed, it has rarely changed this number. The lack of volatility in the prices of these securities is what makes them safe investment options. 🛡

As we’ve seen, some of them provide investors with tax-advantaged income by investing in municipal bonds, on the federal and potentially state-level too. They usually come with no entry or exit charges as well, which is another factor that makes them attractive to potential suitors.

A Problem With Money Mutual Funds ⚠

Nonetheless, MMFs are not a viable option for long-term investment goals of any sort, as they don’t offer much capital appreciation, to say the least. They, in all honesty, don’t manage inflation much better than cash, you’re simply losing your money at a slightly slower pace.

If you are worried about the current state of the market and think it’s reaching unsustainably high numbers, money market funds can be a good place to weather a storm but beware— It can lull you into a false sense of security.

Think of them as a tropical island of sorts, where you temporarily put the anchor down while scouting ahead for your next venture. The mosquitoes of inflation will slowly bleed your precious capital out if you stay out there too long in this tropical paradise.

Money Market Fund Alternatives 📂

I am sure that many of you at this point might be wondering if there are any other, possibly better alternatives for saving your treasure from the scourge of the seven seas which is growing inflation?

Sure, there are several alternative destinations you might pick, but how better they exactly are, that’s debatable, as there are varying pros and cons linked to each one:

Alternative solutionProsCons
Blue Chip Stocks
  • More stable than your average stock
  • Earnings via dividends and shares
  • Slow and steady growth
  • Highly liquid assets
  • Can be very expensive
  • Hard to buy at an optimal price
  • Could be affected by the recession
U.S. Treasury Bonds
  • Fixed rate of income
  • Sell at  high face value once they reach their maturity date
  • Tradeable on secondary markets
  • Some of them have protection against inflation (TIPS)
  • Can take up to several years until their maturity
  • If you want to cash out earlier, they may not be liquid
  •  You might have to pay additional fees if you choose to do so
  • Simplicity
  • Fares good against inflation
  • Prices steadily increase over time
  • Requires physical storage
  • Doesn’t generate passive income
  • Historically bad returns and premium taxes
Money Market Accounts
  • FDIC insured accounts
  • Higher rates than average savings accounts
  • May come with a debit card and check writing privileges as well
  • Returns are still lower than the inflation rate
  • A limited number of monthly withdrawals

What to Keep In Mind When Investing in an MMF 👨‍🏫

So the benefits of diversifying your portfolio via money market funds outweigh the downsides for you and you have decided to set sail after all. There are still several things you should pay closer attention to when choosing the right one, and we will cover the basics of it.

Evaluating an MMF 🕵️‍♂️

The next step would be determining which one would be an optimal fit for your current financial goals and if it aligns with your investment strategy, or if it has minimum investment requirements, your purchase power in general.

Things such as their overall liquidity and short duration should be looked at, especially if your plan is to get out of the investment as soon as possible and divert your funds elsewhere. Easy access to your assets should be imperative if you’re looking at them as a temporary anchoring space for your investment.

The longer you plan on staying in this harbor, the more you should take things such as their overall security and the diversity into account, as well as potential credit quality and tax benefits they may offer.

Potential Risks That Should Be Avoided 🚧

Contrary to bank-issued CDs or savings accounts, MMFs are not FDIC insured. Although they typically invest in high-quality assets and actively work toward protecting the value of your investment, there is a risk that you could lose your coin and that the NAV will drop below the initial $1 per share, although it is a rare occurrence.

And while returns most certainly won’t outpace the inflation, minor ones are still better than no returns at all, so you should be looking for MMFs that are less affected by the inflation risk.

If you decide to invest in prime MMFs, you should as well be aware of the factors that could affect securities in foreign countries that could be also a part of their portfolio. Various political, regulatory, and economic developments could thwart your plans by affecting their ability to pay those securities back in full or on schedule.

Prime and municipal MMFs may temporarily impose a fee upon the sale of your shares or suspend your ability to do so if its liquidity falls below the required minimum due to market conditions. This can prove to be rather unfortunate, especially if you are looking to unload and divert your investment at the right moment.

Conclusion 🏁

MMFs can potentially be a valuable diversifier of your assets. They can provide you with a safe harbor in times of great tempests on the stock market exchange, but they are fickle as the sea breeze in the face of inflation. Therefore, they are not an adequate long-term investment opportunity, not in the slightest.

But they can, if managed correctly, be used as a temporary vessel to reach your financial goals and avoid some rough obstacles on your journey—even save you an extra coin and aid your ambition of sailing away into the sunset of a well-managed and successful financial portfolio.

Money Market Funds: FAQs

  • Can You Lose Money in a Money Market Fund?

    Yes, losses of money are possible in a money market fund. Although it rarely happens, there is a possibility that the NAV drops below $1 per share and if you want to cash out at the moment you would be receiving less than your initial investment.

  • How Often Do Money Market Funds Pay Interest?

    This depends on the fund itself and the type of securities they manage, but most of them pay a monthly interest rate. Keep in mind that this rule is not set in stone by any means—should you wish to check this for a specific fund, you can take a look at their recent distribution history.

  • Are Money Markets FDIC insured?

    No, FDIC does not cover MMFs, although some of the assets included in their portfolios such as CDs can be insured as the institutions that create them are. MMFs are viewed by the government, as investments similar to bonds and stock mutual funds and therefore are not insured.

  • How Are Money Market Funds Taxed?

    Not all money market funds are taxable, to begin with. Investing in MMFs that are made of tax-free municipal bonds could yield you returns free-of-tax on both federal and state levels. As for the ones that are taxable, most of them fall under your federal tax rate and you will be receiving a 1099-INT to help you file these types of income.

  • Are Money Market Funds Safe Today?

    While the average returns of MMFs are generally slow and nowadays dwarfed by inflation rates, using them as a form of long-term investment will most likely yield financial losses. But they are generally considered to be a safe type of investment in terms of volatility and price changes—as long as they are reinvested in a timely manner.

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All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.