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What are Money Market Funds?

2016-11-09T09:28:31+00:00

The term 'Money Market Funds' is included in the Investments edition of the Financial Dictionary. Get yours now on amazon in ebook or paperback format. Read more here...

Money market funds are investment vehicles with a unique objective of keeping a consistent NAV net asset value of $1 each share while they provide interest for their investing share holders. To accomplish this, the portfolio of a money market fund is made up of securities that are short term in nature with maturities which are under a year. These securities typically are liquid debt and money instruments that are of the highest quality. Investors can easily buy money market fund shares by going through banks, brokerage firms, or mutual funds directly.

The ultimate goal of these money market funds is to give their investors a safe haven investment for assets which are both readily accessible and equivalent to cash. In essence they are mutual funds. Among their most common characteristics are that they offer low returns and provide low risk as an investment.

Because these funds offer comparatively lower returns than many other investments, financial advisors recommend that investors not remain in these vehicles as a long term selection. Their returns will not provide sufficient appreciation on capital in order to achieve the investors’ objectives over a longer time frame. Employer provided retirement plans will often sweep employees’ unallocated dollars into these funds until they give orders as to where to invest them specifically.

The pros to money market funds can be significant. They offer more than simply high liquidity and lower risk. A number of investors find them appealing because there are not any fund entrance or exit fees (or loads) as with many mutual funds. A variety of them will offer investors gains which have tax advantages. These come from investments they make in state and federally tax exempt municipal securities. Other investments which these funds could hold include T-bills and other shorter time frame government debt issues, corporate commercial paper, and CDs certificates of deposit.

There are also some downsides to money market funds besides their low returns. Though they are supposed to be stable and consistent in their values, they are not insured by the FDIC Federal Deposit Insurance Corporation. This means that in the rare cases where such funds break the buck, investors can suffer losses of principal. Competing investments like CDs, savings accounts, and money market deposits accounts provide similar returns but do offer this government backed guarantee of principal. This does not stop investors from regarding money market funds as extremely safe. The funds are carefully regulated by the Investment Company Act of 1940.

The government changed the rules on such money market funds regarding their net asset values and in what they could invest in 2014. After that year, the funds were not permitted to set their NAV permanently at $1 any longer. They did this because of the three times in the history of such funds where the $1 share price had been broken (as of 2016). It had created “bank runs” on the assets of the money market funds in 2008 when it occurred most recently in the Financial Crisis.

The American SEC Securities and Exchange Commission decided to prevent this from happening again by changing the fund management rules to provide them with more resilience and better stability. Such new restrictions more strictly limited the assets these funds were allowed to hold. The SEC also introduced triggers that would suspend redemptions and charge liquidity fees to prevent chaos in the markets. The fund managers had to start utilizing a floating NAV which created risk where it was not perceived to exist previously. Individual investors were not impacted by the floating NAV share rule since the funds are designated as retail funds and are exempt from this rule.

The term 'Money Market Funds' is included in the Investments edition of the Financial Dictionary. You can get your copy on amazon in Kindle or Paperback version. See more details here.