Learning about money market funds and how to use them in your investing programs can help you make better investment decisions, both protecting your assets and allowing you to earn more in the long run.
A money market mutual fund is a mutual fund that invests in assets that are so stable that the fund maintains a constant price of $1 per share. Money market funds are not FDIC insured (though some banks have offered savings accounts or even checking accounts with the name "money market" but they are FDIC insured and are not mutual funds).
The money market refers to the instruments in which the the fund invests. The investments include mostly the sorts of instruments that consumers and small investors don't normally buy directly. These include short term treasury obligations (T-bills) and commercial paper (short term corporate obligations). Everything in the portfolio of a money market fund would be expected to mature within a few months. The cash is then reinvested.
Money market funds earn low returns but are generally considered safe despite their lack of a formal guarantee. The industry is carefully regulated and investor losses in this space have been tiny. You can reasonably expect to get your money back with interest.
Most investors look at three primary types of assets for their long term investments. Stocks, bonds and cash. All of these can be accessed using mutual funds. If your family owns mutual funds for its stock and bond investments, it may make sense to put your cash investments in mutual funds, as well. You can keep all of your mutual fund holdings in a brokerage account.
Because cash investments of all sorts, including money market funds, don't generate a lot of interest or dividends, and they don't ever go up in value, they don't make great investments. As some approach retirement, people often like to move a portion of their investments into cash. This lowers the anticipated return on the portfolio but, more importantly, it reduces the risk of loss.
Keeping your cash in a money market fund between investments is generally a wise idea. Let's say you have $20,000 invested in your IRA at a large discount broker. You might make investments in several different mutual funds and end up with some money left over, or you might sell one and decide to take some time to figure out which new fund to invest. These are opportunities to invest in a money market mutual fund so that your cash is safe, but not completely idle.
Some brokerages will put your cash into a money market fund automatically, even if you don't ask for that. Others will give you the option to automatically sweep your cash into a money market fund. Some only make that option available for people with large accounts. Even if you can't sweep all of your balances into a money market account, you can move money into a money market fund just like you move money into a mutual fund that invests in stocks or bonds.
Because of the low returns on money market mutual funds, you want to be sure to avoid any transaction fees (unless you have lots and lots of money invested). Today, a $1,000 investment in a money market fund might only earn $10 in a year. If you have to pay $10 to get in and $10 to get out of a money market fund, you'll lose ten dollars. You'd be better off to have your cash sit idle for a year earning nothing.
Money market mutual funds are a key part of your investment strategy. Though you are unlikely to keep much money in money market funds, you'll almost always want some of your money there.
