Money market funds – How do they work?
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Money market funds – also known as money market mutual funds – are a saving and investing option offered by banks, brokerages and mutual fund companies. A money market fund is often used by people with brokerage accounts who sell a stock and then want a parking spot for the proceeds until they decide where to reinvest the money. But these funds also might be used to build cash for an emergency fund or other short-term goals.
How money market funds work
MMFs are not FDIC-insured, even when you buy them at a bank. That means there is some risk but historically, it has been slight. You may find that the small amount of risk is worth it because money market funds traditionally pay a better interest rate than a bank money market account, or MMA.
Compare money market accounts at Bankrate.com today.
MMFs are regulated by the Securities and Exchange Commission, or the SEC, and are required to invest in short-term debt securities, such as certificates of deposits and U.S. Treasury bills. The funds have historically tried to maintain a share price of $1, but there’s no guarantee a fund will be able to maintain the share price.
There have been 2 cases in which money market funds have “broken the buck,” or failed to maintain the $1 share price. The first involved the Community Bankers U.S. Government Money Market Fund, which was liquidated in 1994 at 96 cents on the dollar. It was an institutional fund and no retail investors lost money.
The second failure was Reserve Primary Money Fund, which broke the buck in 2008. Reserve was the nation’s first money market fund; investors eventually received 99.1 cents per share.
But, by and large, money market funds have not been problematic and have one of the best records for safety.
Under a new SEC rule, share prices may fluctuate on money market mutual funds used by large institutional investors. But MMFs geared toward individual investors will continue to try to maintain a stable $1 share price.
Key facts about money market mutual funds
- They are not FDIC-insured.
- They come with check-writing and money transfer privileges (often with minimum requirements, limitations and fees).
- Withdrawals may have fees.
- They are safe, secure and regulated short-term debt securities.
- Fees (expense ratio) are included to cover fund management.
- There are both taxable and tax-free funds.
Watch ‘expense ratios’
When you hold a money market fund, someone will need to be paid to oversee the fund and manage its investments. So, you’ll pay a fee called the expense ratio, which helps pay the cost of running the fund.
Fees reduce the yield, so it’s always important to look for a fund with a low expense ratio. The trade group the Investment Company Institute says MMF expense ratios have been holding steady and averaged 0.13% of assets in 2015.
You can find the expense ratio information in the prospectus and on many brokerage or stock sites.
Taxable vs. tax-free money market funds
Money market funds are divided into 2 categories: taxable and tax-free. Taxable funds usually pay a higher yield, but that doesn’t always make them a better deal. If you’re weighing a taxable fund against a tax-free fund, you’ll need to do some math called the tax-equivalent yield formula to see which will give you the better return.
Money market funds allow you to write checks and make electronic transfers, but most accounts establish a minimum dollar amount for checks. Electronic, telephone and preauthorized transactions are limited by federal regulations to 6 per month, with no more than 3 being by check, draft or debit card.
Check with your institution to see if it imposes a fee after a certain number of withdrawals if your account balance drops below a certain level.