What are the things you should know about money market funds?

One of the safest yet most liquid investments available to investors is a money market fund. While they might not give very high returns, they do guarantee preservation of capital and easy liquidity. There are a few things one should be aware of and be careful about while investing in money market funds.

Nature of Investment

At its core, a money market fund is basically like any mutual fund, where the amounts invested by multiple investors goes into a common pool which is then suitably invested to give the required returns to each investor. The only way in which a money market fund differs from other mutual funds is in the nature of investments. These funds stay away from risky and volatile stocks which hold the promise of high returns but also carry the risk of a drop in fund value if those stocks perform below expectations. Money market funds usually invest in government bonds and securities and similar financial papers.

Return on Investment

By nature, money market funds are not high return investments. The net asset value of such a fund is $1 at the time of purchase, and most money market funds aim to ensure that this net asset value is maintained at least at $1 for the tenure of the fund. If the net asset value ever falls below the $1 value, then the fund is said to have ‘broken the buck’. So far in the decades old history of money market funds, only twice has the buck been broken, which gives a fair idea of their safety.

Tax Implications

Both taxable and non taxable money market funds are available. Obviously the tax free funds offer lower yields. The tax free money market funds will involve taxation neither on the invested amount nor the gains from the investment. The taxable funds would make you liable for tax payment on the gains on the investment.

Returns vs. Liquidity

The money market funds offer higher returns than regular savings accounts but their returns are much lower than more aggressive investment vehicles. Again, in terms of liquidity, money market funds sold by brokerage firms are almost as liquid as savings accounts.

Insurance

The nature of investments made by money market funds makes them inherently risk free, but one should be aware that unlike savings and other deposit accounts, these investments are not insured by FDIC, so in case the bonds in which the money market funds have invested in fail, then the fund also can go bust.