Money Market Mutual Funds Explained

What are money market mutual funds (money market funds)
Like other mutual funds, money market mutual funds pool the money of investors together to allow them to participate in investments that might otherwise be closed to them. They are regulated by the Securities and Exchange Commission and can only purchase the highest rated debt that will mature in less than 13 months. They are also restricted as to what percentage of their holdings can be of any one issuer.

Their main goals are to maintain principal and pay a modest dividend. They are unique among investment instruments in that they strive to maintain a NAV (Net Asset Value) of $1 per share. While it is possible for the value of the shares to drop below this, the risks are relatively low. However, the funds are not FDIC insured so they are not as liquid and safe as bank accounts.

There are three major types of investments money market mutual funds take part in.

Treasury Bills

These are short-term bonds issued by the US government that will mature in a year or less. Being backed by the government, they are considered very safe assets. This helps keep this type of mutual fund remain very stable.

Federal Securities

Being short-term bonds issued by federal agencies to finance programs and other government functions, these also have very low risk since they are backed by the government.

Tax Exempt Securities

Consisting of local government bonds that are often tax exempt, these are also considered very safe. The fact that they are tax free makes them more attractive.

Corporate Securities

Short-term bonds issued by corporations to cover their immediate needs. They are also frequently referred to as commercial paper. While not as safe as government bonds, they are not exposed to the kinds of fluctuations in value as longer term bonds and are of course far safer than stocks.

What they are not

It is important not to confuse a money market mutual fund with a money market account. While money market accounts also invest in corporate and government securities, they are issued by banks and thus have FDIC insurance. They work somewhat like regular savings accounts but have restrictions such as the number of transactions that can be made every month and minimum balance requirements.

Their functions

Being relatively safe and paying better rates of return than regular savings accounts, they are a good place for money to keep earning a higher rate while remaining very liquid. However, their returns will be lower over time than riskier investments.

Purchasing money market mutual funds

These funds can be purchased directly from mutual fund firms or brokerage companies. They usually have minimum balance requirements from $500 to $5000.

What to look for

Although they are considered very liquid, they are not insured. Therefore, those purchasing money market mutual funds should make sure it is from a reputable firm covered by the Securities Investor Protection Corporation. It is also a good idea to look at the types securities the fund is invested in and the creditworthiness of their holdings.

On the other hand, the current yield of the fund should also be considered. Funds invested in marginally riskier securities will bring slightly higher returns.

Expense ratios for managing the funds will come out of the returns and will add up over time. Therefore, expense ratios should always be looked at.

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