When you want to earn interest, you can find mutual funds that pool your money with other investors. Money market mutual funds invest in government treasury notes and treasury bills, as well as certificates of deposit. Fixed income funds, on the other hand, buy bonds from corporations and government agencies. Both approaches provide income, but you should know how much risk you are taking on and how much you might expect to earn.
Money Market Fund Advantages
A money market fund is very liquid, meaning it’s easy to get your money out. Some come with check-writing privileges. Your money goes into low-risk investments as defined by the Securities and Exchange Commission. These include government-backed securities, certificates of deposit, and loans to banks. While a money market fund is not insured by the Federal Deposit Insurance Corporation, there has only been one instance when investors lost any money in such a fund. That was in 2008, when the Reserve Primary Fund went below one dollar per share. The vast majority of money mutual funds maintain a value of one dollar per share. You can expect to earn better interest than you would in a regular savings account, and in some cases, you can even earn more than a CD would pay.
Money Market Fund Disadvantages
Money market funds cannot compete with the yields you can get on bonds. In fact, many bond issuers set the amount of interest they pay in such a way as to make bonds more attractive than money market funds. For example, a corporation that sees a money market fund paying 2 percent could offer 4 percent or better to entice investors. In addition, money market funds do not pay much more than a money market account at your bank, which is FDIC-insured. Also, you have no opportunity for growth in a money market mutual fund. You can't expect your share price to go above one dollar.
Fixed Income Fund Advantages
Mutual funds that invest in bonds can pay higher interest than you would get from a money market mutual fund. In addition, bond funds offer you the chance to grow the value of your investment. In other words, bonds could rise in value. You still get paid interest and have the added value of capital appreciation. Bond funds diversify across a wide range of investments from government bonds to corporate bonds to foreign bonds. This helps protect you in the event one of the investments go down in value. The others may do better and help make up for the loss.
Fixed Income Fund Disadvantages
Many bond funds expose you to foreign risk. Because they buy bonds from other countries, economic turmoil in those countries could affect the value of your investment. Also, bond funds can lose money. This happens when interest rates rise above the interest paid by the fund's bonds. Investors can make higher interest by buying new bonds that have been issued. They will place a lower value on bonds that pay lower interest. At the close of each trading day, each fund calculates the value of all its assets and divides that by the number of shares people have bought. This is the net-asset value, otherwise known as the price of a share. You could see your share price go down if the fund's holdings get devalued.
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