You’ve been sticking to your budget, and now you’re ready to put some of your hard-earned cash to work. The problem is figuring out which investment option will best help you reach your financial goals. Among the many investment options out there are mutual funds and money market funds.
Money market funds and mutual funds are closely related, with money market funds essentially being the safer offspring of mutual funds. Whether you invest in mutual funds or money market funds, your money will be pooled with other investors by your investment firm. The large sum of money will be distributed into various investment options and securities. If you choose to invest in mutual funds, your investment will consist of higher-risk securities like stocks and bonds, while money market funds are composed of lower-risk investments such as government securities and certificates of deposit.
Net Asset Value
When you invest in either a mutual fund or a money market fund, you're essentially buying shares in the fund, similar to how you might buy shares of a company in the stock market. The number of shares you own is commensurate with how much you invested. Each share in the fund possesses a net asset value, or NAV, which will increase or decrease depending on the performance of the securities that make up the fund. The average NAV of a mutual fund varies, but as the Securities and Exchange Commission notes, investment firms try to keep the NAV of a money market fund around $1, with the yield varying based on the performance of the fund.
Mutual funds and money market funds share many of the same advantages. Both offer portfolio diversity, since the fund is made up of different types of securities. They also offer fast accessibility to your money, unlike other investments, such as certificates of deposit. The diversity offered in both also reduces your chances of actually losing your principal investment. If one security is performing poorly, it may be offset by another that is consistently performing well.
Risk vs. Return
Choosing between money market funds and mutual funds really boils down to deciding how much risk you’re willing to take versus how much of a return you're hoping to make. As with most investments, higher risks create the potential for higher returns. Mutual funds are riskier than money market funds because they contain more volatile and unpredictable securities, such as stocks. You generally won’t lose your principal in a money market fund, because it consists of more secure government securities and Treasury bonds, but the return on a money market is usually less than what you stand to make with a mutual fund.
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