How Do Money Market Funds Work?

Money market funds are short-term investments designed to make back at least as much as you put in.

Money market funds are short-term investments designed to make back at least as much as you put in.

Even if you're an inexperienced investor, you've likely heard of money market funds. But you may be wondering how they differ from other types of investments and if they are worth putting money into. Before you invest in these low-risk mutual funds, it's important to know how they work and what their strengths and weaknesses are.

Features

Money market funds are mutual funds, which means that the money you contribute is invested in assets. The law requires that money market funds be invested in low-risk securities such as government bonds and commercial paper. These short-term securities reach maturity in under a year, at which time you collect your earnings.

Benefits

Money market funds are generally considered low-risk investments, especially in comparison to other mutual funds. They are designed to return at least the amount that you initially invest. For example, if you pay $1 per share, the fund is set up so that you should receive $1 per share return, plus the interest you make. The earnings you receive from money market funds are based on interest and returns are usually higher than those you’d receive from traditional savings accounts. Money market funds are good to use if you have cash that you are interested in investing only for a short while. They can also help you to diversify your portfolio and balance out other riskier investments. You can also typically write checks and make withdrawals from these accounts.

Disadvantages

The major disadvantage to money market funds is that while they are considered low-risk, they are not federally insured, which means there is no guarantee you will make back your investment. While the fund is designed to maintain the value of your investment, it is possible to lose money in a volatile market.

Considerations

Know the differences between a money market fund and a money market deposit account. A money market deposit account is insured by the bank where it is housed, while a money market fund is not insured. Before investing in a money market fund, review the fund’s prospectus and shareholder report to understand the level of risk. Also ask your financial advisor about any fees or expenses involved in investing in these funds.

About the Author

Megan Martin has more than 10 years of experience writing for trade publications and corporate newsletters as well as literary journals. She holds a Bachelor of Arts from the University of Iowa and a Master of Fine Arts in writing from The School of the Art Institute of Chicago.

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