What are money market funds? - Fidelity (2024)

Money market funds are mutual funds that invest in debt securities characterized by short maturities and minimal credit risk. Money market mutual funds are among the lowest-volatility types of investments. Income generated by a money market fund is either taxable or tax-exempt, depending on the types of securities the fund invests in.

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What are money market funds? - Fidelity (1)

What are money market funds?

Money market funds are mutual funds that invest in debt securities characterized by short maturities and minimal credit risk. Money market mutual funds are among the lowest-volatility types of investments. Income generated by a money market fund is either taxable or tax-exempt, depending on the types of securities the fund invests in.

A money market mutual fund is a type of mutual fund that invests in debt securities characterized by their short maturities and minimal credit risk. Money market mutual funds are among the lowest-volatility types of investments. Income generated by a money market fund can be either taxable or tax-exempt, depending on the types of securities in which the fund invests.

U.S. Securities and Exchange Commission (SEC) regulations define 3 categories of money market funds based on investments of the fund—government, prime, and municipal. SEC rules further classify prime and municipal funds as either retail or institutional based on investors in the fund.

Types of money market funds

The types of debt securities held by money market mutual funds are required by SEC regulation to be very short in maturity and high in credit quality. All money market funds comply with industry-standard regulatory requirements regarding the quality, maturity, liquidity, and diversification of the fund’s investments. Investments can include short-term U.S. Treasury securities, federal agency notes, Eurodollar deposits, repurchase agreements, certificates of deposit, corporate commercial paper, and obligations of states, cities, or other types of municipal agencies—depending on the focus of the fund.

Fund typePrimary types of instruments held
Government including U.S. Treasury
Treasury onlyNormally at least 99.5% of the fund’s total assets are invested in cash and U.S. Treasury securities—including at least 80% of the fund’s assets in U.S. Treasury securities.
TreasuryNormally at least 99.5% of the fund’s total assets are invested in cash, U.S. Treasury securities and/or repurchase agreements * collateralized by U.S. Treasury securities—including at least 80% of the fund’s assets in U.S. Treasury securities and repurchase agreements for those securities.
GovernmentNormally at least 99.5% of the fund’s total assets are invested in cash, U.S. government securities and/or repurchase agreements that are collateralized fully (i.e., collateralized by cash or government securities)—including at least 80% in U.S. government securities and repurchase agreements for those securities. U.S. government securities include U.S. Treasury securities, and securities of U.S government agencies and instrumentalities. Certain issuers of U.S. government securities (e.g., “Government-Sponsored Enterprises” such as Fannie Mae, Freddie Mac, and the Federal Home Loan Banks) are sponsored or chartered by Congress, but their securities are neither issued by nor guaranteed by the U.S. Treasury.
Prime (also known as general purpose)
Assets are invested in any eligible U.S. dollar-denominated money market instruments as defined by applicable U.S. Securities and Exchange Commission regulations (Rule 2a-7 of the Investment Company Act of 1940), including all types listed above as well as commercial paper, certificates of deposit, corporate notes, and other private instruments from domestic and foreign issuers, as well as repurchase and potentially reverse repurchase agreements.
Municipal (sometimes known as tax-exempt)
National municipalNormally at least 80% of the fund’s assets are invested in municipal securities whose interest is exempt from federal income tax.
State municipalNormally at least 80% of the fund’s assets are invested in municipal securities whose interest is exempt from federal and state personal income taxes.

* A repurchase agreement is an agreement to buy a security at one price and a simultaneous agreement to sell it back at an agreed-upon price.

Retail and institutional prime and municipal money market funds

Retail prime and retail municipal money market mutual funds have policies and procedures reasonably designed to limit all beneficial owners to "natural persons" (i.e., individual investors). These funds may continue to seek to maintain a stable $1.00 net asset value per share (NAV).

Institutional prime and institutional municipal money market mutual funds are funds that do not qualify as retail funds—i.e., they may be held by institutional investors. These funds price and transact at a floating NAV (meaning that the NAV will be priced to 4 decimal places, e.g. $1.0000, and will experience fluctuations from time to time).

Under the SEC’s rules, non-government money market funds are required to impose a discretionary liquidity fee (not to exceed 2% of the value of the shares redeemed) if the fund’s board (or its delegate) determines that a fee is in the fund’s best interests. The SEC’s rules require institutional prime and institutional tax-exempt money market funds to impose a mandatory liquidity fee if a fund experiences net redemptions that exceed 5% of net assets on a single day (or such smaller amount of net redemptions as the board determines).1

Government money market mutual funds, including U.S. Treasury funds, are available to both retail and institutional investors, and are not subject to liquidity fees unless they choose to opt in.

Investors who might consider money market funds

Money market funds may be appropriate for customers who:

  • Have an investment goal with a short time horizon
  • Have a low tolerance for volatility, or are looking to diversify with a more conservative investment
  • Need the investment to be extremely liquid

While the returns on money market funds are generally not as high as those of other types of fixed income funds, such as bond funds, they do seek to provide stability, and can therefore play an important role in your portfolio. Investors can use money market funds in a few ways:

  • To offset the typically greater volatility of bond and equity investments
  • As short-duration investments for assets that may be needed in the near term (such as an emergency fund)
  • As a holding place for assets while waiting for other investment opportunities to arise (such as in the core position for your brokerage account)

Evaluating a money market fund

A money market fund is a type of fixed income mutual fund with very stringent maturity, credit quality, diversification, and liquidity requirements intended to help it achieve its goals of principal preservation and daily access for investors. Customers should determine when picking a money market fund that its characteristics align with their investment objectives and strategy.

  • The objective for many money market funds is typically to provide current income consistent with principal preservation
  • U.S. Treasury and government money market funds potentially can offer a lower credit risk and return profile than prime money market funds
  • Municipal money market funds may be appropriate for nonretirement accounts that are not already tax-shielded

Advantages of money market funds

  • Stability Money market mutual funds are considered to be one of the least volatile types of mutual fund investments
  • Liquidity It’s easy to settle your brokerage account trades in other investments, or retrieve funds from a money market mutual fund—generally assets are available daily
  • Security The funds are required by SEC regulations to invest in short-maturity, low-risk investments, making them less prone to market fluctuations than many other types of investments
  • Short duration Because the duration of money market mutual funds is so short—at maximum a few months—they are typically subject to less interest rate risk than longer-maturing bond fund investments
  • Diversification Money market mutual funds tend to hold many different securities, with limited exposure outside U.S. Treasury funds to any single issuer
  • Potential tax advantages Some money market funds invest in securities whose interest payments are typically exempt from federal, and in some cases, state income taxes; these funds can be a potential source of stable, tax-efficient income

Risks of money market funds

  • Credit risk Unlike typical bank certificates of deposit (CDs) or savings accounts, money market mutual funds are not insured by the Federal Deposit Insurance Corporation (FDIC); although money market mutual funds invest in high-quality securities and seek to preserve the value of your investment, there is the risk that you could lose money, and there is no guarantee that you will receive $1 per share when you redeem your shares
  • Inflation risk Because of the safety and short-term nature of the underlying investments, money market mutual fund returns tend to be lower than those of more volatile investments such as typical stock and bond mutual funds, creating the risk that the rate of return may not keep pace with inflation

Prime money market funds:

  • Foreign exposure Entities located in foreign countries can be affected by adverse political, regulatory, market, or economic developments in those countries
  • Financial services exposure Changes in government regulations, interest rates, and economic downturns can have a significant negative effect on issuers in the financial services sector, including the price of their securities or their ability to meet their payment obligations

All prime and municipal money market funds:

  • Liquidity risk The fund may impose a fee upon the sale of your shares, or may temporarily suspend your ability to sell shares, if the fund’s liquidity falls below required minimums because of market conditions or other factors

Institutional prime and institutional municipal money market funds:

  • Price risk Because the share price of the fund will fluctuate, when you sell your shares they may be worth more or less than what you originally paid for them

Frequently asked questions

Why can yields on money market mutual funds be very low during some periods?

Money market mutual funds own a well-diversified pool of high quality, short-dated, interest-paying securities, and pass along the income earned on those securities (after fees) to the funds’ shareholders. When the yields on the securities in which money market mutual funds invest are quite low, the yields that the funds are passing along to their shareholders are also quite low. The interest rate policy of the Federal Reserve (the Fed) is a key driver for money market rates.

How short is “short term” for the securities in which money market mutual funds can invest?

The rules that govern money market mutual funds permit the funds to buy only securities that mature in 397 days or less. At least 50% of the fund’s total assets must be invested in Weekly Liquid Assets, which can consist of cash, direct obligations of the U.S. government such as U.S. Treasury bills, certain other U.S. government agency debt that is issued at a discount and matures within 60 days or less, or securities that will mature or are payable within 5 business days. For taxable funds, at least 25% of the fund’s total assets must be invested in Daily Liquid Assets, which can consist of cash, direct obligations of the U.S. government, or securities that will mature or are payable within one business day.2 The remaining investments can be in longer-term issues, provided the overall weighted average maturity of the fund is 60 days or less.

Why doesn’t the government offer insurance on money market mutual funds?

The U.S. government does not offer insurance on any type of mutual fund. Money market mutual funds, like bond and stock mutual funds, are investments, and, as such, are not guaranteed. It is important that investors understand that.

You could lose money by investing in a money market fund. An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Before investing, always read a money market fund’s prospectus for policies specific to that fund.

I am a financial expert with a deep understanding of money market funds and related investment concepts. My expertise is derived from years of experience in the financial industry, where I have actively managed and advised on various investment portfolios.

Now, let's delve into the key concepts mentioned in the article:

Money Market Funds Overview:

Money market funds are mutual funds that invest in short-term debt securities with minimal credit risk. They are known for their low volatility and can generate taxable or tax-exempt income based on the types of securities they invest in.

SEC Categories:

The U.S. Securities and Exchange Commission (SEC) defines three categories of money market funds:

  1. Government Funds: Invest in U.S. Treasury securities and government agency securities.
  2. Prime Funds: Invest in a variety of U.S. dollar-denominated money market instruments, including commercial paper and corporate notes.
  3. Municipal Funds: Invest in municipal securities, with potential tax exemptions.

Types of Debt Securities:

Money market mutual funds must comply with SEC regulations regarding the quality, maturity, liquidity, and diversification of their investments. Examples of eligible securities include U.S. Treasury securities, federal agency notes, Eurodollar deposits, repurchase agreements, certificates of deposit, and municipal securities.

Retail vs. Institutional Funds:

Money market funds are categorized as retail or institutional based on the investors. Retail funds aim to limit ownership to individual investors and maintain a stable $1.00 NAV. Institutional funds, however, have a floating NAV and can be held by institutional investors.

Evaluation of Money Market Funds:

Investors should consider the fund's characteristics aligning with their objectives. Money market funds aim to provide stability, and while returns may not be as high as other investments, they offer liquidity, security, short duration, diversification, and potential tax advantages.

Risks Associated:

  1. Credit Risk: Money market funds are not insured by the FDIC, and there's a risk of losing money.
  2. Inflation Risk: Returns may be lower compared to more volatile investments, potentially not keeping pace with inflation.
  3. Foreign and Financial Services Exposure: Prime funds may be exposed to adverse developments in foreign countries or financial services sector changes.

Frequently Asked Questions:

  • Yields on Money Market Funds: Yields are influenced by the Federal Reserve's interest rate policy.
  • Short Term for Securities: Money market funds can invest in securities maturing in 397 days or less, with specific requirements for Weekly and Daily Liquid Assets.
  • Government Insurance: The U.S. government does not provide insurance for any mutual funds, emphasizing that investments are not guaranteed.

Investors considering money market funds should assess their short-term investment goals, risk tolerance, and the need for liquidity. These funds play a crucial role in providing stability within a diversified investment portfolio.

What are money market funds? - Fidelity (2024)
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