What is Money Market Fund and How it Works

Money Market Fund is a great way to invest and earn high returns. It is an excellent investment option for beginner investors who are looking for low-risk, liquid and short-term investments. A money market fund generates an income that is tax free, but with little capital appreciation.

Money Market Fund Definition

A money market fund is a mutual fund that invests in short term and liquid instruments like cash, cash equivalent securities and high credit rating securities. Money market funds follow guidelines issued by financial regulators like the Securities and Exchange Commission in the U.S thereby, making them safe and secure.

How a Money Market Fund Works

A Money Market Fund works the same as a mutual fund. It issues units or shares to investors that earn some interest. Returns from the money market fund depend on the preparing interest rates in the market. Money market funds invest in the following money market instruments.

  • Certificates of Deposit. It is a short term certificate issued by the bank and has a short maturity term.
  • Commercial paper. They are issued by corporate and financial institutions to facilitate their short term borrowing.
  • Repurchase agreement. It is a short-term borrowing for those dealing in government securities.
  • Treasury bill. It is issued by the government to raise funds for a period of up to 1 year. They are very safe and secure but have lower returns compared to other money market instruments.

Money market funds are regulated by financial regulators that provide a guideline, characteristics and their maturity. For instance, in the US, the Money Market Fund is regulated by the Securities and Exchange Commission (SEC).

Experienced investors can shop around for the best short term debt instruments available. These instruments often have higher interest rates, but with some level of risk. On the other side, a less experienced investor looking for a short term and low risk investment can take the money market fund route. By so doing, he will delegate money management to a fund manager. An investor can withdraw money at any time but there is a limit on the number of times he can withdraw.

Types of Money Market Funds

A money market fund is classified depending on assets invested and maturity period. The following are some types of money market funds.

  • Prime Money Fund. It invests in commercial papers that are issued by corporations and government agencies.
  • Government Money Fund. It invests a minimum of 99.5% of its total assets in cash, government securities and repurchase agreements.
  • Treasury Fund. This is a money market fund that is issued by the government to borrow money from the public. It can be in form of a Treasury bill, Treasury bond, or treasury notes.
  • Tax-Exempt Money Fund. This is a kind of money market fund whose earnings are tax-free.

List of Best Money Market Funds

Investing in the money market fund is ideal for investors looking for liquid, low risk and short term investments. The following is a list of the best money market funds.

1. Vanguard Federal Money Market Fund

You can get started with the Vanguard Federal Money Market Fund with a minimum investment of $3,000. It invests at least 99.5% of its assets in U.S government securities repurchase agreements and cash. It has a 7-day yield of 0.01%.

2. Vanguard Treasury Money Market Fund

Vanguard Treasury Money Market Fund mainly invests in the U.S Treasury securities but also invests in securities like agency debt and repurchase agreements. It has a minimum investment of $50,000 and a 7-day yield of 0.01% and 0.09% expense ratio.

3. Fidelity Investments Money Market Portfolio

Fidelity Investments Money Market Portfolio requires a minimum investment of $1,000,000 with a 7-day yield of 0.01% and an expense ratio of 0.18%. It invests in U.S. government securities, dollar-denominated money market securities of domestic and foreign issuers, and repurchase agreements

4. Fidelity Money Market Fund

Fidelity Money Market Fund is also among the most accessible to investors with a $0 minimum investment. It has a 7-day yield of 0.01% and an expense ratio of 0.42%. More than 25% of its total assets are instruments issued by financial institutions.

Advantages of a Money Market Fund

Money market funds have the following advantages.

  • Low risk
  • Short term investment
  • High liquidity
  • High returns on investment

Disadvantages of Money Market Fund

  • Little capital appreciation
  • Not insured by FDIC
  • Interest rates are dependent on the current market

Vincent is a writer with an interest in finance, business, technology and health niche. He holds a Bachelors degree in Applied Statistics with computing. Read more about Vincent and see our complete editorial team at FiFi.