Recently, I’ve recommended a money market mutual fund to a few friends who had money sitting idly in bank savings accounts. I knew they needed to keep the money safe, but it could still be earning some interest. So, I was surprised to hear from a couple of them last week as the stock market was gyrating.
Both were concerned that their savings could be in jeopardy, though neither had seen any changes in their account values. So, I knew I had not done a very good job of helping them understand where they had put their money.
Money market mutual funds are a safe place to put money that you need to be there under any circumstances. They are perfect for holding money you are saving for an emergency or a big ticket purchase. They are an alternative to high yield savings accounts, which have gotten a lot of press lately.
My friends’ confusion may have come from the idea that money market funds are mutual funds. Mutual funds can invest in any kind of asset. True, about half of all the money invested by mutual funds is invested in stocks, but there are funds that invest in all sorts of things other than stocks.
Money market mutual funds do not invest in stocks at all. There are strict regulations regarding what a money market fund can hold and still be classified as a money market fund. These funds only invest in high-quality short-term debt instruments. In fact, they cannot invest in anything that will pay off in more than 13 months, and the average time to pay off of all their holdings must be 60 days or less.
These debt instruments range from Treasury bills, which are the short-term debt of the U.S. Government, to short-term loans to well heeled private companies. The interest earned by these instruments are the source of income on the money market fund. The income is usually paid out monthly in the form of a dividend to the fund shareholders.
Money market funds usually offer higher returns than a savings account, and recently some funds’ yields have surpassed even high yield savings account yields. Money market funds can be easier to deal with than a high yield savings account, where you may find restrictions on the number of withdrawals you can make in a given month.
The big difference is that money market funds are not insured. A savings account at a bank, even a high yield savings account at an on-line bank, is FDIC insured up to $250,000. If your bank goes out of business, you will get your balance up to that amount back from the Government.
Money market funds rely on diversification, high credit quality and short-term exposures to maintain their steady $1 per share value. They offer no guarantee, yet they have been consistently successful at managing their risk. Since their introduction in the 1970s, only two funds have had their share values drop below $1; one in 1994 due to large holdings in unconventional investments and one in 2008 due to a large holding of Lehman Brothers debt.
While a loss is theoretically possible, money market funds have historically been and continue to be a safe alternative to bank savings accounts. They offer an opportunity to earn a bit of better return on your money without giving up flexibility. The value of your investment there will not be impacted by anything that happens in the stock market. So you can rest assured your money will be there when you need it.
Photo by Alexandra Gorn on Unsplash
Save Yourself; Your Guide to Saving for Retirement and Building Financial Security, is available on Amazon.
4 thoughts on “There is No Stock in Money Market Funds”
Mind elaborating on differences between high yield online saving accounts and money market funds? Why would you recommend one over the other? Cheers mate.
On-line savings accounts are like your brick and mortar savings accounts, but the on-line banks tend to pay more interest. On-line savings accounts are also backed by the FDIC up to $200,000. On-line savings accounts may have restrictions on the number or timing of withdrawals. Money market mutual funds offer safe returns like a savings account, but the investments that support the interest rates are a bit different. Some offer better rates of return than on-line bank savings accounts. Money market funds with Federal or Treasury in the name are guaranteed by the government, but pay lower rates of return, than other money market funds that are not guaranteed.
Those around me say I’m too conservative-thinking when it comes to finances. I only believe in the store existing saving accounts even though they have less interest (those are the ones I grew up knowing). Would you still recommend to continue placing my money there, or do online ones (somehow I think they are riskier although they are FDIC insured) or this money market mutual fund? Talking about 10-20K.
The on-line accounts are just as safe as a traditional savings account, but if you’re not comfortable with them, you’re not losing much. Ally Bank, for example is currently paying 1.60% annual interest. My favorite money market fund, the Vanguard Prime Money Market fund, is paying the same. So on $10,000, you would only be giving up $160 a year in interest. It’s not a huge gain. So if you’re happy at your bank, stay with them.