We'll cover the basics of how to invest in money market funds in this article, but for more detailed information you may want to enroll in an online course or two.
Money market funds offer investors the advantage of stability and liquidity at higher returns than those available from a bank account. Money market funds are available through a variety of institutions, most commonly mutual fund companies and banks or credit unions.
Opening a money market account in most cases is as simple as sending in a completed application with your initial investment. Some funds will waive the initial investment requirement if you establish automatic investments from your bank account. You will need to provide your name, residential address, social security number, and date of birth; all financial institutions are required to retain this information under the USA Patriot Act.
You should consider the following as you evaluate your investment options:
- How much you have to invest, and how much of a balance you can maintain. As with bank accounts, money market funds tend to offer higher rates of return, the larger your investment and/or balance.
- How much liquidity you need. Most money market funds offer electronic redemption services by wire or Automated Clearing House (ACH). If you desire additional convenience, consider a fund that offers check writing services. Keep in mind that most funds have a minimum transaction amount (usually $250.00 or more) for redemptions by check.
- Your tax situation. Investors in higher tax brackets should consider money market funds that invest in municipal bonds, as earnings from these funds are exempt from federal and/or state income tax. This information should be clearly set forth in the fund’s prospectus and fact sheet.
- The type of account and your investment time frame. Money market funds make sense for college or retirement accounts only if you are or will soon be taking distributions.
Be sure to check fund offerings at institutions you already do business with – many institutions may waive fees and/or balance requirements for current depositors or shareholders.
Investors must keep in mind that money market funds are not FDIC-insured. Although the funds seek to maintain a constant price of $1.00 per share, several funds “broke the buck” in the immediate aftermath of the 2008 financial crisis. Although the U.S. Treasury Department helped stabilize these funds, new investors will be subject to the same, albeit remote, risk of loss.
Traditional alternatives to money market funds include bank-issued Certificates of Deposit (CDs). CDs generally guarantee the investor’s principal and pay a higher rate of interest, but charge a penalty for early withdrawal. Ultra-short bond funds offer higher potential returns and greater liquidity than CDs, but these funds have a fluctuating share price and sustained heavy losses in the 2007-2008 financial crisis. Investors seeking to earn interest on their cash without undue risk or lack of access to the principal will still find money market funds to be their best option.
Other options for learning about money market funds include meeting with a financial advisor, or enrolling in online classes.