In this article:
- What Are Money Market Funds?
- Pros of Money Market Funds
- Cons of Money Market Funds
- Alternatives to Money Market Funds
Money market funds are mutual funds that focus on short-term, low-risk investments. They could lead to better returns than you might have with savings accounts or similarly named money market accounts—especially when interest rates are on the rise. But like any investment, they aren't risk-free. Consider these pros and cons before investing in money market funds.
What Are Money Market Funds?
Money market funds pool money from investors to buy and sell different types of securities. Typically, these are short-term investments that have a low risk profile, such as certificates of deposit (CDs) and U.S. Treasuries. Some issue regular dividend payments, which can provide a steady stream of income and higher returns than deposit accounts. Just keep in mind that money market funds are not insured by the Federal Deposit Insurance Corp. (FDIC).
These investment funds tend to be actively managed by a fund manager who makes investment decisions on behalf of investors. You can purchase money market funds through a brokerage account and certain retirement accounts.
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Pros of Money Market Funds
They're Considered Relatively Low-Risk Investments
While hedge funds and certain stock funds focus on high-risk, high-return investments, money market funds reside on the lower end of the risk spectrum. It's highly unlikely that you'll lose money with a government-backed bond or a CD that's issued by a creditworthy financial institution. Stocks, on the other hand, carry much more risk.
Earnings Could Outperform Some Deposit Accounts
With money market funds, savings accounts and money market accounts, yields generally follow the federal funds rate. When this rate goes up, annual percentage yields (APYs) tend to do the same. In today's rising-rates environment, money market funds may offer strong returns. Some currently have seven-day yields that top 5%. What's more, money market funds may be quick to react when the federal funds rate increases. Financial institutions, on the other hand, may be slow to increase the rates on their deposit accounts.
Some Money Market Funds Have a Low Initial Investment
While some money market funds require thousands of dollars to get started, others have no initial investment. That means they're available to virtually all investors. But like any financial product, it's always best to shop around and compare money market funds from different fund management companies. Before investing, review the fund's performance and read its prospectus to better understand its investment goals.
Cons of Money Market Funds
Your Money Could Earn More Elsewhere
High-risk investments could provide better returns in the long run. For the past century, average annual stock market returns have been about 10%. But you may be in for a bumpier ride with stocks, thanks to regular market volatility. CDs are considered a safer place to keep your cash—and returns could outpace money market funds. As of November 2023, some CD yields are as high as 6.5%.
Your Funds Are Uninsured
If you open a CD or a checking, savings or money market account from a bank, your funds are FDIC-insured. Credit unions offer similar protection. Certain investments are also covered through registered brokerage firms. Money market funds, however, are uninsured. You could lose money if your fund management company becomes insolvent.
You Can Expect Fees
The operating expense ratio is a fee that covers the fund's operational costs. It's often expressed as a percentage of fund assets. For example, an expense ratio of 0.59% means that you'd pay $59 for every $10,000 that's managed. Some money market funds also charge withdrawal fees if too many people try to offload their investments at once.
Alternatives to Money Market Funds
- High-yield savings account: This type of savings account offers above-average interest rates and easy access to your money. Some of the best high-yield savings accounts have rates that are well over 5%. Your funds are insured, providing additional peace of mind.
- Money market account: A money market account earns interest and allows you to withdraw funds with relative ease. Account holders can typically use a debit card or checkbook to pay bills and make purchases. Some money market accounts currently have APYs as high as 5.25%.
- CDs: If you don't need access to your money right away, CDs could be a good option. Your funds are locked in for the duration of the CD term (early withdrawal penalties usually apply), but returns may outshine some money market funds.
- Exchange-traded funds (ETFs): ETFs allow you to buy baskets of different securities in one trade. That provides built-in diversification. But unlike money market funds, ETFs trade like stocks and have greater flexibility.
The Bottom Line
Money market funds can help diversify your portfolio and provide steady dividend payments. They typically invest in low-risk, short-term investments and may provide better returns than savings accounts. However, your funds are uninsured and fees may come with the territory. Whether it's right for you will depend on your goals and financial situation.
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