What is a Money Market Fund?

Money Market Fund

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Money Market Fund

A money market fund is a type of mutual fund that invests in highly liquid, short-term financial instruments. These instruments typically include government securities, treasury bills, commercial paper (short-term unsecured debt issued by corporations), certificates of deposit, and other low-risk, highly liquid securities.

Money market funds aim to maintain a stable value, typically $1 per share, while paying dividends to investors. The goal is to provide investors with a safe place to invest money that can be withdrawn at any time without the loss of value, similar to a deposit in a checking or savings account but typically with higher interest rates.

Because of their focus on low-risk, short-term investments, money market funds are often used by investors as a place to hold cash equivalents, especially in volatile market conditions. They are also commonly used for the “sweep” function in brokerage accounts, where leftover cash is automatically moved into a money market fund to earn a small return until it is reinvested.

However, while money market funds are generally considered safe, they are not entirely without risk. They do not have FDIC insurance protection like a bank savings account, and it is possible (though very rare) for a money market fund to “break the buck”, or fall below the $1 per share value. This happened to a few funds during the financial crisis in 2008, though new regulations have been put in place since then to reduce the risk of it happening again.

Example of a Money Market Fund

Let’s say you have some extra cash in your savings account that you’d like to put to work, but you don’t want to invest in higher risk assets like stocks because you may need the money in the short term. You might choose to invest this money into a money market fund.

You choose a money market fund from a well-known investment company. This fund invests in a diversified portfolio of short-term, high-quality, liquid securities such as U.S. Treasury bills, commercial paper from reputable corporations, and certificates of deposit from highly-rated banks. The fund’s primary objectives are to maintain a stable value of $1 per share and to pay dividends to investors.

You invest $10,000 into this fund. This means you get 10,000 shares (because the share price of a money market fund aims to maintain at $1). The fund has a yield of 1.5% per year, which is more than you would earn in a typical savings account. This interest is typically paid out in the form of additional shares in the fund.

So, if you hold your investment for a year, at the end of the year, you’d have about 10,150 shares in the money market fund. If you choose to cash out at this point, you’d receive approximately $10,150 (excluding any fees). If you need the money before the year ends, you can usually withdraw it at any time without penalty, as money market funds are designed to be highly liquid.

Remember that while money market funds are relatively low-risk investments, they are not entirely risk-free. They do not carry the FDIC insurance that a bank savings account would have. Also, their return rates are generally low compared to other investments like stocks or bonds, reflecting their low-risk nature.

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