What is a money market fund?

Money market funds are a type of low-cost and low-risk mutual fund you can invest in to earn a modest rate of return.

Derek Silva

Derek Silva

Published April 26, 2019

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KEY TAKEAWAYS

  • A money market fund is a type of low-risk investment that costs $1 per share and pays a steady return

  • Money market funds are also used as a brokerage account’s settlement fund, which is where your money may go when you sell stock or receive dividends

  • You may be able to avoid income taxes on your gains if you invest through a retirement account or municipal fund

  • Money market funds (MMFs) are similar to money market accounts (MMAs) which are savings accounts with guaranteed interest rates and insurance

A money market fund is a type of mutual fund that consists of low-risk, short-term investments, allowing an investor to buy shares of the fund and earn a steady rate of return. These funds are highly liquid (meaning you can withdraw or trasnfer money quickly) and one share of a mutual fund costs just $1.

Brokerage accounts and retirement accounts, like traditional IRAs, also use money market funds as settlement funds. A settlement fund is a fund where your money usually goes after you sell investments or receive dividends. You can then withdraw the money from your settlement fund.

Money market funds are generally affordable, but investing in one may require a minimum investment of $3,000 or more, just like with other mutual funds. That makes them less accessible than most high-yield savings accounts and money market accounts, which work very similarly but are a type of savings account and not an investment.

In this article:

What is a money market fund?

A money market fund, also called a money market mutual fund, is a mutual fund that’s composed of many individual securities (investments) that are low-risk and pay out regularly. The regular payments, which go to whomever manages the fund, are what allow a financial institution to offer you consistent returns.

A mutual fund usually consists of fixed-income securities, also called debt securities, with short maturities (typically paying out in one year or less). A fixed-income security pays a set amount of money after a certain time period in addition to interest payments, as with a certificate of deposit (CD).

Some of the most common fund investments are Treasury bonds and commercial paper — debt that’s issued by a corporation and works similarly to a bond. Investing in cash is also common. A cash investment is a short-term debt, often with a maturity of 90 days or less.

You may also see a money market fund’s securities described as high-quality. A high-quality bond or debt security is one with a very high likelihood of paying out when its term is over. Lower-quality bonds have a higher risk of default, but may also offer bigger returns.

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3 types of money market funds

There are three main types of money market funds:

  • A government money market fund invests in government securities, including Treasury bills. There are multiple types of government funds, depending on the exact securities in the fund.
  • A prime money market fund is a general fund that may invest in commercial paper, CDs, or other short-term securities.
  • A municipal money market fund invests in state or local government securities.

Funds may also cater to retail investors (individual investors) and institutional investors, who usually buy in high volumes. As an example, there are both retail prime and institutional prime money market funds.

How much does a money market fund cost?

The financial institution you open your investment account with is required by the U.S. Securities and Exchange Commission (SEC) to maintain the net asset value (NAV) — the cost to buy one share of the fund — at $1 per share.

Many people use a money market mutual fund attached to a brokerage account — as a settlement fund — which is money they can then use to buy stocks or other investments. If you independently invest in a money market fund, you will probably have to make a minimum investment of $3,000 or more. (Consider an ETF if you’re looking for an investment with lower minimums.)

Also remember that every mutual fund has an expense ratio, — a set percentage that you pay as a management fee. The expense ratio is typically relatively low, like less than three-fourths of one percent per year. It will be subtracted from your gains, so make sure to compare funds’ performances and expense ratios before investing.

How much does a money market fund earn?

There are many different money market funds, and the return you get depends on which you invest in. In general, you can get a rate of return that’s 1% or more, which is comparable to some high-yield savings accounts.

You may also need to pay income tax on your earnings from a money market fund.

Can you lose money in a money market fund?

Like any other investment, it is possible to lose money in a money market fund, but that’s not common. These funds generally have a very low risk of default and even though they may not be quite as safe as a standard savings account, a quality money market fund is, relatively speaking, very safe.

Are money market funds taxable?

Gains from a money market fund are treated the same as regular investment gains, so you usually need to pay capital gains tax. There are two main exceptions: retirement accounts and municipal funds.

Since you don’t pay annual taxes on the growth of a retirement account’s investments, you wouldn’t owe annual income tax on a fund that’s in your retirement account. You may still pay income tax when you withdraw money, though, such as with a 401(k) plan.

You may also save on taxes by investing in municipal money market funds. In a national municipal fund, at least 80% of assets are invested in municipal securities and since their interest is exempt from federal income tax, your gains may be exempt. Similarly, there are state municipal funds where your gains may be exempt from federal and state income tax.

Should you invest in a money market fund?

Before buying shares of a money market fund (or any investment) it’s important to know what your investing goals are. If you’re looking for an investment that will help you grow your money over decades so that you have a solid nest egg when you retire, you should probably consider something other than a money market fund.

A money market fund may help you grow an emergency savings fund or save for a short-term savings goal. You’ll get higher returns than many savings accounts and a high level of liquidity, meaning you can easily withdraw money or transfer it to another bank.

Money market funds may also help you maintain your savings while still making some gains. For example, someone who’s nearing retirement age may want to shift their portfolio from more high-risk investments to more low-risk investments.

For more help managing your investments, talk with a financial advisor.

Money market funds vs money market accounts

Money market funds and money market accounts are similar and even offer similar rates of return, but a money market account is a savings account and a money market fund is an investment.

You can open a money market account (MMA) at a bank or credit union. Your money is insured by the FDIC, just like with all other savings accounts, and you can withdraw it at any time. Some MMAs also come with a debit card and personal checks. You earn interest and the APYs are usually higher than traditional savings accounts.

A money market fund is a type of investment, so you usually need to open one through a brokerage. You can earn money off your investment, but it isn’t a guaranteed interest rate like at a bank. The FDIC does not insure your money, but it may be insured by a lesser-known nonprofit organization, called the Securities Investor Protection Corporation (SIPC). The SIPC is not a government agency but its existence is mandated by federal law.

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About the author

Personal Finance Expert

Derek Silva

Personal Finance Expert

Derek is a tax expert at Policygenius in New York City. He has written about multiple personal finance topics in the past, and his work has been covered by Yahoo Finance, MSN, Business Insider and CNBC.

Policygenius’ editorial content is not written by an insurance agent. It’s intended for informational purposes and should not be considered legal or financial advice. Consult a professional to learn what financial products are right for you.

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