What Is a Money Market Fund? Are They Right for Your Portfolio?

Consider the following scenarios:

• Market volatility has ramped up, leading you to seek relatively higher returns than a bank account but with minimal price volatility.
• You’ve got a short- or medium-term goal on the horizon, such as a car or home purchase, and you’re looking for an investment product that’s similar to a cash savings account but with a potentially higher yield.
• You’re intrigued by the idea of investing in institutional assets, such as commercial paper, municipal securities, and repurchase agreements, but you’re a retail investor, so you’d like a simple product that pools many of these securities into one fund.

What is a money market fund?

Money market funds are essentially mutual funds that invest in money market instruments: U.S. Treasuries, municipal securities, certificates of deposit (CDs), commercial paper, repurchase agreements, and bankers’ acceptances. Not sure what these instruments are? Keep reading.

First, note that a money market “fund” is not the same as a money market “account.” A money market fund is a type of mutual fund that invests in money market instruments; hence, it’s an investment product that you must directly buy or sell.

But let’s back up for a moment. In case you aren’t familiar with any of these terms, here’s a brief explanation:

• Money market instruments designate an assortment of highly liquid debt securities, most of which have short-term maturity dates, and all of which are issued by creditworthy government or banking institutions. Investors typically gain indirect access to these individual securities through a money market account, an interest-bearing account that offers higher yield than the average savings account.
• Money market funds, on the other hand, are investment products that combine different money market instruments to pursue a diversified range of debt exposure and yield. Their objective is to earn interest with minimum risk while maintaining a net asset value (NAV) of $1 per share, although it’s important to remember this can’t be guaranteed. (Note: Institutionally held funds are subject to a floating NAV, meaning in certain situations they might deviate from the stable $1 NAV. Funds held by retail investors and government institutions, however, may be exempt from this floating NAV requirement.) It’s also important to note money market funds are not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. The fund’s sponsor has no legal obligation to provide financial support to the fund, and you should not expect the sponsor to provide financial support to the fund at any time.

What do money market funds invest in?

In general, money market mutual funds invest in six types of securities. Depending on a given fund’s specific target (as detailed in its prospectus), it may invest in some or all of these security types:

• U.S. Treasuries: Interest-paying debt securities—bills, notes, and bonds—issued by the U.S. government; maturities range from one to 30 years.
• Municipal securities (“munis”):Interest-paying securities that municipal and state governments issue to finance various operations.
• Certificate of deposit (CD): A promissory note issued by a bank that agrees to pay a fixed amount of interest in exchange for depositing cash for a specified time period.
• Commercial paper: Short-term debt (promissory notes) issued by companies to pay liabilities that need to be met immediately; maturities typically last no longer than 270 days.
• Repurchase agreement (repo): A short-term debt agreement in which a dealer, selling government securities to an investor as collateral in exchange for cash, agrees to “repurchase” the securities, typically on the following day at a price that includes interest.
• Bankers’ acceptances: A promised future payment, similar to a post-dated check, issued and guaranteed by a bank.   

You may not be as familiar with the last three asset classes—commercial paper, repurchase agreements, and bankers’ acceptances—as you are with the first three. No surprise: They’re generally unavailable to retail investors. Instead, they’re traded between financial and corporate institutions. But money market mutual funds make them available to retail investors.

What are some types of money market funds?

Money market funds can be grouped into three general categories: 

• Government money market funds: As the name implies, these funds are limited to government securities, such as U.S. Treasuries (bonds, notes, and bills) and collateralized repos involving Treasuries. This category also includes so-called government-sponsored enterprises (GSEs), such as Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. It’s important to note, however, that GSE debt is typically not guaranteed by the U.S. government.  
• Municipal money market funds: These are often called “tax-exempt” funds because interest on munis is exempt from federal income tax.  
• Prime money market funds: Prime funds are also called “general-purpose” money markets because assets can be invested in any of the security types listed above. 

Each type of money market fund is typically considered to be a lower risk investment (and we’ll look at the potential risks below). But in general, prime funds are the most risky of the three, followed by muni funds. Government funds are seen as having the least amount of risk of the three, and within that category, government funds with a high concentration of Treasuries—with full government backing—are seen as having the least amount of risk. 

What are the pros and cons of money market funds?

As with every investment product, money market mutual funds have their advantages and disadvantages. It’s important to assess how these opportunities and limitations align with your financial goals, investment style, and risk tolerance as you consider money market investing.

The pros

Money market mutual funds are designed to provide steady interest income with low risk. Shares held by “retail” investors, although not guaranteed, seek to maintain a NAV of $1 per share.

Some money market funds, namely those investing in certain municipal securities, can provide a tax advantage at the state and federal level. Unlike actual money market accounts, money market funds generally require a comparably lower minimum investment. Remember: Because money market funds pool assets from multiple investors and typically invest in a wide array of investments, they can give retail investors exposure to a diversified portfolio of securities at a lower minimum investment. Some money market funds are more diversified than others, so it’s important to read each fund’s prospectus before investing. 

Also, if you’re a retail investor who wishes to gain exposure to commercial paper, repos, or bankers’ acceptances—investments typically available to institutional investors—money market funds allow you such exposure.

Money market funds generally have a lower expense ratio and don’t impose withdrawal fees. However, keep in mind, some companies charge a small annual fee or may charge a fee if the amount invested in the fund is below a minimum threshold. Also, many money market funds limit the number of times you can withdraw in a month. 

The cons

Although money market mutual funds are typically considered a lower risk investment, it is possible to lose money by investing in such funds. They aren’t FDIC insured, nor are they guaranteed by the U.S. government or a government agency. Money market funds aren’t deposits or obligations of or guaranteed by any bank (unlike the money market accounts offered by your local bank, which are typically FDIC insured). And it’s important to remember that because mutual funds aren’t traded during the day like stocks and exchange-traded funds (ETFs), you may not have intraday access to money held in money market funds.   

Another thing to consider when you invest in money market mutual funds is that their yield may not always keep up with the rate of inflation, meaning your gains may experience erosion during periods of higher inflation. Finally, money market funds may not match the higher growth potential of stocks and other investment products that carry higher risk.

Tax-advantaged funds may pay dividends that are subject to the alternative minimum tax and, despite the name, may have tax obligations if they happen to hold investments in taxable obligations.

You can learn more about these funds by visiting the TD Ameritrade Money Market Funds page. Remember that these funds are part of a much larger family of mutual funds offered at TD Ameritrade.