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A relatively safe way to invest is through a money market fund. These funds are less risky than stock mutual funds and pay a return that reflects short-term interest rates. Keep in mind, however, that money markets typically are not insured by the federal government (although some money market deposit accounts managed by banks can be, so ask first).
How they work
Just like stock funds invest in a basket of equities, money markets invest in a variety of financial vehicles, including government securities, certificates of deposit, or CDs, commercial paper and other low-risk, highly liquid securities. Banks, brokerage firms and mutual fund companies offer money market funds.
The goal of a money market fund is to keep the share price at $1 yet offer a variable yield. If the investments perform poorly, however, the share price could fall below $1. Losses in money market funds are rare, but if too many people try to redeem at once it can happen. For instance, in 1994, the Community Bankers U.S. Government Money Market Fund was liquidated at 96 cents on the dollar.
And in 2008, the Reserve Primary Fund “broke the buck,” meaning its shares also fell below $1. In general, however, money market funds are considered very safe.
Types of money market funds
There are two types of money market funds, taxable and tax-free. A taxable money market fund typically pays a higher yield, but that doesn’t mean you are getting the best deal. Before choosing a fund, check your return using the tax-equivalent yield formula explained on Bankrate.com (you should know your effective federal tax bracket to figure it).
A money market fund will let you write checks and make electronic transfers, but the number of transactions is likely limited. Make sure to read all of the information available on the fund before investing — such as the prospectus, fund profile and the most recent shareholder report.
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