Beginner's Guide to Money Market Funds

Unlike bank deposits, investments in money market funds are not guaranteed.
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Investing is like everything else in life. One minute you're riding high, the next minute you're rolling on the dirt wondering where that tree came from. It's easy to be confident about your investments when the markets are up, but when they take a nasty tumble a lot of investors start looking for a safe haven where they can park their money. One safe place to ride things out is a money market fund, an extra-conservative type of mutual fund.

They're Mutual Funds...

Money market funds are the same as other mutual funds in their basic structure. A mutual fund gathers together contributions from thousands of small investors to make up a single pool of capital. This lets the fund managers act like a large investor, taking positions in a wide range of investments. Diversifying their capital helps protect the fund and its investors from losses, while still -- ideally -- offering acceptable returns. In practice, there are several types of mutual funds, with investment styles ranging from aggressive and high-risk to conservative and low-risk.

...But Different

Money market funds are the most conservative and low-risk mutual funds of all. By law, they're required to keep their portfolios invested in the safest possible places. That includes government securities, CDs and commercial paper from the most stable of companies. The share value or Net Asset Value -- NAV -- of most mutual funds varies depending on the performance of its underlying investments. Money market funds manipulate the value of their portfolios to keep their NAV at $1. Typically they pay a better return than CDs and other purely interest-bearing products. It's possible, but very rare, for a money market fund to lose money.

...Almost Like a Bank Account

Money market funds are designed to provide a maximum of liquidity. In investment-speak, that means you can get your money whenever you want it. In fact, money market funds can be used much like a bank account. You deposit or withdraw funds as you wish, and even write checks on the account. They'll typically offer an interest rate higher than your bank's high-yield savings accounts, but, like those accounts, they'll require you to start with a minimum deposit. They might also require you maintain a minimum balance to remain in the account. Some funds also limit your use of checks, or impose service charges after you use a certain number.

How to Use Them

If you're looking for a useful place to keep part of your investment capital during uncertain times, that's when you'll want to have a money market fund. They're not FDIC protected, but in practice it's very difficult to lose money in one. However, you won't retire comfortably on what they earn you. Think of your money market fund as a convenient harbour for your money to ride out a storm before returning to active duty. If you see the opportunity to put your money back into an investment with a higher yield, jump on it. That's exactly why they make it easy to get your money out.

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