The world of deposits, investing, and savings have all been extremely dynamic places to be over the last year or so. Inflation, rate increases, and a stock market correction have all led investors into some new and strange places seeking ways to earn interest.
Enter the money market mutual fund*. Money market funds have become extremely popular places for investors to park cash, as they offer very competitive yields and excellent liquidity.
What are these funds that are capturing billions of dollars of cash? What are the pros and cons of them? Who would use such funds?
These investments are mutual funds1 first and foremost. What is a mutual fund? It’s a basket of securities that’s put together by a company, then re-sold to the general public in pieces, or shares. Money market mutual funds use short-term bonds as their building blocks. These bonds can be anything from municipal bonds to federal bonds to commercial paper or many other similar securities. The fund manager will disclose what type of bonds they’re using as the basis for the fund.
Because these funds use short-term bonds and because they primarily use government-backed securities, they are generally considered extremely safe. What they are NOT, however, is FDIC-insured. These are mutual funds, not bank accounts. On a relative risk basis, they would be considered riskier than a true bank deposit.
How do they earn interest? How do they pay interest?
While it varies by company and by fund, most of these funds advertise their 7-day yield as their benchmark for returns. This is basically the net return that the fund should generate over 12 months, based upon 7 days of performance. That yield can change from week to week, as the interest rate environment changes.
A unique thing about these mutual funds is that they attempt to peg their share price at $1 and keep it stable, however it is possible to lose money by investing in the fund. A shareholder’s price doesn’t increase over time. That leads into an interesting fact. In 2008, during the financial crisis, many of these funds actually could not support their share price at $1. As these share prices fell below $1, investors lost value.
How do these funds fit into an investor’s portfolio?
Money market mutual funds can be a good way to park cash for an investor. They offer generally competitive rates for a relatively safe investment, and they’re very easy to invest in. Many don’t have any sales fees attached. They do have a couple of drawbacks that any person should consider before investing in them. They’re not insured by the FDIC, and they have a variable return. Investors wanting more stability and predictability should probably look into bank CD’s2 or bank money market accounts. As with any investment, there is no “perfect” choice. Understand what these funds can do and make smart decisions about how best to use them.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
*An investment in these Funds are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although these Funds seeks to preserve the value of your investment, it is possible to lose money by investing in these Funds.
1 Investing in mutual funds involves risk, including possible loss of principal. Fund value will fluctuate with market conditions and it may not achieve its investment objective.
2 CD’s are FDIC Insured to specific limits and offer a fixed rate of return if held to maturity, whereas investing in securities is subject to market risk including loss of principal.