It’s not overselling it to say the money market is one of the foundations of the whole financial system. However, not a lot of people understand or even know about it.
The money market is where we make large volumes of purchases and sales of short-term debt products. This market is famous for the security and liquidity it provides.
As a result, this market is also an excellent venue for investors who want those two things. Are you looking for a safe and liquid investment vehicle? Check out money market funds.
What are Money Market Funds?
If you’ve been dabbling in the financial markets for some time now, you’ve probably heard about mutual funds. It’s where many different investors pool their money together while a fund manager invests the fund in various stocks, bonds, currencies, and other assets.
Well, a money market fund is a type of mutual fund. However, it only invests in highly liquid instruments. We’re talking about assets like:
- Cash equivalents
- Debt-based securities (only those with high ratings and short-term maturity of less than a year)
Thus, such funds are highly liquid and sport low levels of risk.
Money Market Fund vs. Money Market Account
But you shouldn’t confuse this fund to a money market account. Remember that these two are entirely different things.
A money market fund is an investment. Behind it, there’s an investment company, so you get no guarantees that you’d get your capital back.
A money market account, meanwhile, is a savings account from financial institutions. There’s the interest you can earn, and also get some transaction privileges. The Federal Deposit Insurance Corporation (FDIC) also insures the account. Essentially, that means you’re always going to get a portion of your money back no matter what happens.
Types of Money Market Funds
There are different types of money market funds. Being mutual funds, they are categorized based on the types of assets in which the fund is invested.
For instance, a government money market fund has 99.5% of its assets in a mix of cash, government assets, and fully collateralized repurchase agreements.
A treasury fund, meanwhile, invests in US Treasury debt securities like T-bills, T-bonds, and T-notes. There’s also a tax-exempt fund, which gives earnings minus the US federal income tax.
Apart from these, there are many other reasons to invest in money market funds.
When the market, for example, gets very shaky and volatile, you can park your money on money market funds. Stocks and bonds can fluctuate in value wildly, but money market investments usually stay put.
Of course, there are some downsides, too. For instance:
- Your purchasing power can be eroded because the rate of return you’ll get maybe a lot slower than the inflation rate.
- Sometimes, there are annual fees. Such fees can eat away from the 2% to 3% interest you get from the fund.
- Of course, the elephant in the room, these funds aren’t insured by the FDIC, so you’re not going to have any chances of getting your money back should the fund go belly up.
Nonetheless, money market funds are still highly recommended for investors who want to control the risks they’re taking. They’re highly secure, highly liquid, and highly trusted by many investors.