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Money Market Funds: Types, Advantages, And Disadvantages
Money market funds are special types of mutual funds that invest in extremely liquid instruments that are near-term. These instruments may include cash, high-end credit rating, currency equivalent securities, and debt-based securities that have a short-term maturity, like the U.S. Treasures.
Money market funds intend to offer investors high liquidity with a considerably low level of risk. They are also known as money market mutual funds.
Well, this was just a small brief. But, if you wish to know more in details, you are here at the right place.
In this article, I shall take you through every single detail that exists about money market funds. This would help you improve your knowledge and make a well-thought-out decision if you wish to invest in one.
So, without any further delay, let us begin.
What Is A Money Market Fund?
Money market funds are a kind of mutual funds that have comparatively lower risks than any other mutual funds or any other investments in general. However, they, have had lower returns.
Money market funds generally invest in short-term and high-quality debt securities and pay for dividends that usually are a reflection of short-term rates of interest.
Multiple investors make use of money market funds to be able to preserve cash or as an alternative way to invest in the stock market.
While they may sound pretty similar, money market funds and money market accounts are not the same. While money market funds are investments that an investment fund company sponsors and have no guaranteed principal, money market accounts are a type of interest-earning savings account. A bank or a financial institution offers money market accounts. The Federal Deposit Insurance Corporation insures the money market accounts, and they offer only limited transaction privileges.
Key Takeaways
- Money market funds are a category of mutual funds that invest in short-term and high-quality debt instruments that include cash or cash equivalents.
- Although they are not as safe as cash, money market funds are a tremendously low risk on the spectrum of investments.
- While a money market fund generates high income, the capital appreciation is very little.
- These funds must be used as a platform to park money for a temporary period of time before an individual decides to invest it somewhere else or build an anticipated outlay of cash. Money market funds are not the best fit for long-term investments.
How Do Money Market Funds Function?
These funds function just like your everyday mutual fund. They issue units and shares to investors that are redeemable, and it is a mandate for them to follow guidelines that are curated by financial regulators. For instance, the guidelines that are drafted by the Securities and Exchange Commission of the US.
Here is a list of debt-based financial instruments where money market funds may invest.
Bankers? Acceptance or BA: short-term debt that a commercial bank guarantees
Certificates of deposit or CDs: bank-issued certificates of savings that have short-term maturity.
Commercial paper: an unsecured short-term corporate debt
Repurchase agreements or Repo: short-term government securities
U.S. Treasures: Government-based short-term debt issues
Returns that you may get from these instruments are dependent upon the applicable market fund rates, and hence, the returns overall from the money market funds are also based on the rate of interest.
Money Market Funds And Its Types
MMFs are categorized into various types based on the class of assets that are invested, the total maturity period, and various other attributes.
So, let us now see how we can break down money market funds based on the various attributes.
Prime Money Fund
The prime money funds invest in the debt of floating rate and the business papers of non-Treasury assets such as the ones that corporations, government-sponsored enterprises, and U.S. government-based agencies issue.
Government Money Fund
A government money fund generally invests in almost 99.5% of the total assets: cash, repurchase agreements, and government securities, which are fully collateralized by either cash or government securities.
Treasury Fund
A treasury fund will invest in the standard debt securities that the U.S. Treasury issues, like the Treasury Bonds, Treasury Bills, and Treasury Notes.
Advantages And Disadvantages Of Money Market Fund
Money market funds are always in direct competition with other similar investment options like the bank money market accounts, enhanced cash funds, and ultrashort bond funds. These investing options may invest in a more extensive variety of assets and may as well aim for greater returns
The fundamental purpose of money market funds is to provide a safe area for investing for investors in not just a secured but also highly liquid avenue, cash equivalents, and debt-based assets by using smaller-sized investment accounts.
In the kingdom of investments like mutual funds, one may characterize MMFs as less risky and low-return investments.
Multiple investors find it preferable to store substantial amounts of cash in money market funds for a shorter term. However, you might not want to invest in a money market fund for a long-term investment goal, such as retirement planning. This is because they do not offer a lot of capital appreciation.
Investors find MMFs attractive as they bear no load like entry or exit charges. Multiple funds also offer the investors tax- benefits by investing in municipal securities that may have tax exemption at the federal tax law.
Pros
- They come with a very low risk.
- They are highly liquid.
- They give investors a better return than most of the bank accounts.
Cons
- They are not insured by FDIC
- The capital appreciation is considerably low.
- They may be pretty sensitive to fluctuations in interest rates and monetary policies.
The Bottom Line
In today?s date, money market funds have become one of the founding pillars of capital markets. For investors, they provide a diverse and professionally managed portfolio that offers high liquidity.
Most investors make use of MMFs as an option to store their cash till they can find a better investing option or to make up for the short-term monetary needs.
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