What are money market mutual funds?

When inflation is high, interest rates tend to increase — and remain high — in many areas of global and personal finance. This describes the prevailing economic environment over the past two and a half years.

If you buy a house or carry credit card debt, high interest rates can put you at a disadvantage. The higher the interest rate, the more interest you can expect to pay on these loan balances. However, in a high-interest-rate environment, you will generally find better opportunities to earn more money on your savings.

For many savers and investors, money market mutual funds make sense regardless of interest rates, but even more sense when rates are relatively high.

What are money market mutual funds?

A money market fund is a relatively low-risk mutual fund that invests in short-term securities, posing little credit risk. Introduced in the 1970s, these funds typically pay more interest than savings accounts, particularly the deposit accounts offered by large, brick-and-mortar banks. Money market fund rates are sometimes slightly higher than the interest rates online banks advertise for high-yield savings accounts.

Don’t confuse money market funds with money market accounts. They’re two different things. Banks and credit unions offer money market accounts, which function more like traditional savings accounts but often pay higher interest rates with limited transactions. The Federal Deposit Insurance Corporation (FDIC) insures money market accounts up to $250,000 per account owner at a single institution.

Money market funds do not receive the same FDIC protection. However, they’re generally a safe place to earn solid interest on money you’re saving or waiting to invest in the stock market.

Types of money market mutual funds

The United States Securities and Exchange Commission (SEC) classifies three main types of money market mutual funds:

• Government money market funds: Funds with at least 99.5% of their portfolios in cash and/or government securities, often US Treasury securities.
• Municipal money market funds: Funds with portfolios that consist of bonds issued by municipalities, such as local and state governments. Investors in these funds are exempt from paying federal income tax on their earnings.
• Prime money market funds: Prime funds invest in corporate and bank debt.

Money market funds are further grouped into those for everyday, retail investors and those for larger, institutional investors, the latter generally requiring large minimum investments.

With the basics out of the way, this line from a 2023 Government Accountability Office (GAO) report succinctly gets at the heart of what a money market mutual fund is and does: “MMFs act as intermediaries between investors seeking liquid, safe investments and corporate and government entities that issue short-term debt.”

Money market mutual funds in the current financial climate

In the current high interest rate environment, money market funds remain attractive and competitive with bank deposit accounts, such as checking and savings accounts and certificates of deposit (CDs). With the best money market fund yields hovering around 5%, they’re right there with or even better than high-yield savings accounts.

However, all eyes are on the Federal Reserve Board and the federal funds rate. Rates on money market mutual funds move in line with Fed decisions on interest rates. According to Crane Data founder Peter Crane, when the Fed cuts rates, it takes around 40 days for money market fund rates to drop commensurate with the size of the Fed’s move.

While most economists see rate cuts on the horizon, inflation, while cooling over the long term, remains persistent. Between December and January, consumer prices increased at their fastest rate in months. At 2.4%, as of January, the inflation rate is still holding higher than the Fed’s target of 2.0%. So, while they’re likely to come eventually, rate cuts might not be imminent. If they’re a mid-to-late 2024 event, the current climate remains robust for investors seeking yield from money market mutual funds.

Alternatives to money market mutual funds

When you think about alternatives to money market funds, consider utility and your goals.

For example, if you want a debit card, the ability to write checks and other traditional banking features, you might opt for a money market account. Distinct from a money market fund, money market accounts are bank deposit accounts that typically come with traditional banking privileges. Think of them like hybrid checking-savings accounts with, in the case of many online banks, competitive interest rates.

On the other hand, if you seek a higher rate of return, you might want to consider more aggressive investments. While past performance doesn’t predict future results, the stock market generally outperforms other types of investments over time, specifically relatively conservative bank deposit accounts and money market mutual funds, even during periods when these types of accounts pay higher interest rates.

Regulations around money market mutual funds

Money market mutual funds work like other types of investments. While stock and bond funds own — as their names imply — portfolios of stocks and bonds, money market funds hold fixed-income securities as detailed above.

As is true for other mutual funds, money market mutual funds trade based on net asset value (NAV). Like the share price of a stock, the NAV of mutual funds tends to change daily. However, money market mutual funds aim to maintain an NAV of $1 per share. Because money market funds tend to stay stable at an NAV of $1, they are considered low-risk investments.

But there are exceptions. During the financial crisis of 2007 and 2008 and at the beginning of the pandemic, investors experienced runs on money market funds similar to those that sometimes occur on banks, when a much higher-than-usual number of customers move to withdraw money from their accounts.

As indicated in the above-mentioned GAO report, the federal government, led by the SEC, routinely monitors these situations and, after the aforementioned events, implemented new and enhanced rules, regulations and safeguards to prevent run-risk and further protect money market fund investors.

With all of this said, runs don’t necessarily result in money market mutual funds “breaking the buck.” This slang refers to what happens when a fund’s NAV drops below $1. In fact, breaking the buck has only happened twice, most notably in 2008 when the collapse of Lehman Brothers precipitated the decline of the Reserve Primary Fund’s NAV to below $0.995. There have been near misses, which were most often followed by voluntary sponsor bailouts to ensure the fund could maintain its $1 NAV.

On the ground, you invest in money market mutual funds the same way as other types of investments, usually through your brokerage account. As the fund makes distributions, you’ll typically receive that income monthly — in the form of a dividend — to reinvest into new shares of the fund or take as cash.

What are the typical fees and charges associated with money market funds?

When considering money market mutual fund fees, the main thing to assess is the fund’s expense ratio. An expense ratio is the annual management cost incurred by the fund.

Here’s an example from one of the nation’s biggest mutual fund companies, Vanguard. It’s pretty straightforward. The firm’s money market fund expense ratios range between 0.09% and 0.16%, meaning you’ll pay between $9 and $16 in fees per $10,000 invested.

In a low-interest-rate environment, expense ratios can eat into investment returns. In any environment, it makes sense to seek out the lowest, most competitive expense ratios to preserve as much of your investment capital as possible.

You should also be aware of liquidity and gate fees. These potential fees came about as a result of runs on money market funds, as discussed earlier.

Fidelity Investments nicely summarizes how they work:

“The SEC’s rules permit some money market mutual funds to limit redemptions under certain conditions. Specifically, if a fund’s weekly liquid assets were to fall below 30%, the board of directors of a prime (general purpose) fund or a municipal fund may either charge a liquidity fee of up to 2% on shareholder redemptions or impose a halt on all shareholder redemptions (known as a “gate”) for no longer than 10 days. Additionally, if weekly liquid assets were to fall below 10%, a prime or municipal fund must impose a liquidity fee of 1%, unless the fund’s board determines that such a fee is not in the fund’s best interests … Government and US Treasury money market mutual funds will not be subject to liquidity fees or redemption gates.”

How to choose the right money market mutual fund

The right fund for you depends on your individual circumstances, particularly how much money you have to invest and your tax situation.

Step 1: Choose between taxable or tax-exempt

Money market mutual funds are either taxable or tax-exempt.

For example, municipal money market funds fall into the tax-exempt category. They provide income free from federal tax obligations. In the case of a fund with municipal bonds from a specific state, you will not pay state or local income tax if you live in that state.

Taxable money market mutual funds tend to have higher yields than tax-exempt funds, however, you’ll have to pay taxes on the income these funds generate.

Step 2: Consider expense ratios

After considering taxes, look at expense ratios. Based on the Vanguard data presented above and our survey of the present money market fund landscape, there are plenty of strong offerings with expense ratios of 0.4% or less. In fact, you can find many large money market mutual funds with much lower expense ratios in the 0.1% to 0.35% range. Many of these funds come with minimum initial investments ranging from $0 to $3,000.

Step 3: Search for strong yields

From here, pay attention to yield.

We provide an example of how money market yield works below in our frequently asked questions. In simple terms, yield refers to the return a money market fund is expected to generate.

When interest rates are high, money market fund yields also tend to be high. In fact, as of March 2024, you can find a large number of money market funds from major firms, such as Vanguard, Charles Schwab and T. Rowe Price, yielding 5% or more, putting them in line with what you can expect from high-yield savings accounts.

Generally speaking, the money market fund route tends to work best for a place to stash cash over the short term, whereas a savings account or certificate of deposit might make more sense for longer durations.

How to find money market mutual funds

You can discover and compare money market mutual funds using the same approach you likely use for other mutual funds, exchange-traded funds (ETFs) and stocks. If you have a brokerage account with a firm such as TD Ameritrade, it will usually include a list of the money market funds it offers on its website.

The Office of Financial Research has a super-useful tool called the US Money Market Monitor. Simply search for a firm or specific fund, then drill down to receive details on the money market funds that firm manages along with specific asset information for each fund.

Risks associated with money market mutual funds

As indicated, run-risk is real, although uncommon. While money market mutual funds aren’t volatile like stock or bond funds can be, they don’t come with FDIC insurance, so you can lose money, though government safeguards mentioned in this guide do help provide additional security and stability in the case of unforeseen events. While run-risk is real, breaking the buck is extremely rare.

Of the three main categories — government, municipal and prime — government money market mutual funds are generally considered safest because the US Treasury securities they invest in have the backing of the federal government.

Frequently asked questions (FAQs)