A money market fund sounds simple, but many people misunderstand what it really is. Some assume it works like a savings account. Others think it carries the same risks as stocks. Both assumptions miss the mark.
This article explains what a money market fund is, how it works, and what it invests in. You will also see how it compares to other common places to hold cash, so you can decide whether it fits your needs.
The approach here stays practical. No hype, no sales language, and no unnecessary detail. The goal is clarity, so you can make a confident call.
What Is a Money Market Fund?
A money market fund is an investment fund designed to hold cash while earning interest. It invests in short-term, high-quality debt rather than stocks or long-term bonds.
Money market funds exist to provide stability and liquidity. They aim to preserve your principal while paying a yield that often tracks short-term interest rates.
Unlike bank accounts, money market funds are investment products. They sit inside brokerage accounts rather than checking or savings accounts.
Key Characteristics:
- Purpose: Preserve cash while earning interest
- Structure: Mutual fund or exchange-traded fund
- Typical Volatility: Very low
- Primary Use Case: Short-term cash storage
How Money Market Funds Work
Money market funds pool investor money and lend it out for very short periods. These loans usually last days or weeks rather than years.
The fund earns interest on those loans and passes that income to investors. Returns change over time because interest rates change.
Where the Money Is Invested
Money market funds focus on debt that carries low credit risk and short maturities. This structure helps keep prices stable.
Common holdings include:
- Treasury Bills: Short-term debt issued by the United States government
- Government Agency Securities: Debt backed by federal agencies
- Corporate Commercial Paper: Short-term loans issued by large companies
How Returns Are Generated
Returns come from interest payments on the underlying securities. The fund collects that income and distributes it to shareholders.
Yields rise when short-term interest rates increase. Yields fall when rates decline. The fund itself does not lock in long-term rates.
Net Asset Value Explained
Most money market funds aim to maintain a net asset value of $1 per share. This pricing helps the fund behave like cash rather than a fluctuating investment.
“Breaking the buck” happens when a fund’s value drops below $1. This outcome remains rare and usually occurs during severe financial stress.
Types of Money Market Funds
Money market funds fall into three main categories. Each type balances yield, risk, and tax treatment in different ways.
Government Money Market Funds
Government money market funds invest only in government-backed debt. These funds focus on stability rather than yield.
They often appeal to conservative investors who want minimal credit risk.
Prime Money Market Funds
Prime money market funds invest in high-quality corporate debt. These funds typically offer higher yields than government funds.
They carry slightly higher risk because corporate issuers lack government backing.
Municipal Money Market Funds
Municipal money market funds invest in short-term debt issued by states and cities. The interest often qualifies for federal tax exemption.
These funds work best for investors in higher tax brackets.
Are Money Market Funds Safe?
Money market funds rank among the lowest-risk investment options. Risk still exists, but it looks different than stock market risk.
Safety depends on the type of fund and the quality of its holdings.
Risk Level Explained
Money market funds face three main risks:
- Credit Risk: The chance an issuer fails to repay debt
- Interest Rate Risk: Limited impact due to short maturities
- Liquidity Risk: Usually low because holdings mature quickly
What Happens During Market Stress
During financial crises, some funds have faced pressure. Regulatory changes after 2008 increased liquidity requirements and oversight.
Modern funds hold more cash-like assets and face stricter rules designed to reduce stress-related problems.
Money Market Funds vs. Other Cash Options
Money market funds compete with several common cash vehicles. Each option solves a slightly different problem.
Money Market Funds vs. High-Yield Savings Accounts
High-yield savings accounts are bank products. Money market funds are investment products.
Savings accounts offer Federal Deposit Insurance Corporation protection. Money market funds do not, though they often provide higher yields when rates rise.
Money Market Funds vs. Money Market Accounts
Money market accounts come from banks. They often include debit cards or checks.
Money market funds focus purely on cash storage and yield. Access usually requires selling shares rather than writing checks.
Money Market Funds vs. Certificates of Deposit
Certificates of deposit (CDs) lock money for a fixed term. Early withdrawals trigger penalties.
Money market funds allow access at any time. Yields adjust as rates change rather than staying fixed.
Pros & Cons of Money Market Funds
Money market funds offer clear advantages, but they are not perfect. Weighing both sides helps avoid surprises later.
Pros
Money market funds work well when safety and access matter more than growth. They often perform best when short-term interest rates are elevated.
Key benefits include:
- Competitive Yields: Returns often exceed traditional savings accounts during higher-rate periods
- Daily Liquidity: Shares can usually be sold any business day
- Price Stability: Funds aim to keep share prices steady
Cons
Despite their conservative design, money market funds still carry trade-offs. These limits matter depending on how you plan to use the money.
Common drawbacks include:
- No Federal Deposit Insurance Corporation Coverage: Investment products lack deposit insurance
- Variable Returns: Yields can drop quickly when rates fall
- Minimum Investments: Some funds require larger starting balances
How Money Market Fund Yields Are Quoted
Money market fund yields look different from bank interest rates. Knowing how yields are presented prevents false comparisons.
The most common figure is the 7-day SEC yield. This number reflects recent income rather than long-term results.
Important yield details include:
- 7-Day SEC Yield: Standardized measure based on recent interest income
- Not Guaranteed: Yield changes as interest rates move
- Comparison Tool: Useful for evaluating similar funds
Always compare funds using the same yield metric. Mixing yield types leads to misleading conclusions.
When a Money Market Fund Makes Sense
Money market funds work best as a short-term holding place. They shine when flexibility matters.
These funds often fit well in the following situations:
- Temporary Cash Parking: Holding money between investment decisions
- Emergency Funds for Investors: Cash inside brokerage accounts
- Large Balances: Situations where yield matters more than insurance
When It May Not Be the Best Choice
Money market funds are not designed for long-term growth. Other tools serve that role better.
They may fall short in these cases:
- Long-Term Goals: Growth-focused investing needs higher-return assets
- Small Balances: Insurance protection may matter more than yield
- Falling Rate Periods: Returns may trail savings accounts temporarily
How to Buy a Money Market Fund
Buying a money market fund is straightforward once you have a brokerage account. Most major brokerages offer several options.
Common access points include:
- Taxable Brokerage Accounts: Most frequent use case
- Retirement Accounts: Often used as a cash position
- Automatic Cash Sweeps: Some brokerages move idle cash into funds
Always review minimum investment rules and expense ratios before buying.
Tax Treatment of Money Market Funds
Taxes depend on the type of fund you choose. Interest income usually counts as ordinary income.
Key tax points include:
- Federal Taxes: Most interest is taxable
- State Taxes: Treasury-focused funds may receive favorable treatment
- Municipal Funds: Often exempt from federal income taxes
Tax rules vary by location and situation, so personal context matters
Bottom Line
Money market funds fill a specific role. They offer a place to hold cash with steady access and competitive income. They work best for short-term needs and larger balances. For long-term growth or guaranteed protection, other options make more sense.
Used correctly, a money market fund acts as a practical cash management tool rather than a growth strategy.