To learn about money market mutual funds, watch this 1-minute video or scroll down to read the full article
By: Robert F. Abbott, freelance writer and author of Big Macs & Our Pensions
Perhaps you’ve accumulated some savings but still want to do more research before investing in funds or stocks. Or maybe you get out of equity (stock) funds in September and October each year (always a good idea).
Whatever the reason, you would likely put your idle savings in a money market mutual fund while waiting. You wouldn’t earn much interest, but your money would be safe, and easy to access when you’re ready to invest.
Safety of Money Market Mutual Funds
Let’s deal with the safety issue first, since that’s a priority for many investors. Money market mutual funds are similar to bond funds in many ways, but only include bonds with very short durations. Typically (and this will depend on the country in which you live or invest), durations will be less than a year, and probably average no more than 90 days.
Because of such short time horizons, a fund’s managers will have a good idea of what the future holds for their fund. And, since these funds hold only government notes or very high quality corporate notes, the default risk on a money market fund is negligible.
All of this safety comes at a cost, though. Everything else being equal, a money market fund will earn less than a bond fund or an equity fund. Still, you’ll earn a little bit of interest on your cash, which is better than nothing, and you can sleep well at night.
The second money fund issue is access. Typically, a money market fund will sit within your brokerage account, and you’ll move money back and forth within the account without incurring any penalties. You simply buy other mutual funds (or stocks or anything else) using money drawn from your money market fund, or you tell you sell your other mutual funds and deposit the proceeds in your money market fund.
Which brings us to another important point: Be careful you don’t pay anything to buy or hold a money market mutual fund. If you pay a commission to a salesperson, or pay the fees to hold the funds, you may end up losing money, rather than making it. Your ‘margins’ are very thin, and any costs associated with the fund could move you into negative territory.
To add insult to injury, you could end up paying taxes on the interest you might have received. If your money market fund is outside a registered retirement plan, you may pay income taxes on the interest you earn.
Having said all that, normally you would expect a money market mutual fund to pay more than a simple savings account. And, in most cases, find it more convenient for shifting money in and out of investments than a savings account.
Money market mutual funds have a place in the portfolios of all investors. Whether that’s for safety, convenience, or something else is up to you.
Next, learn about Index Mutual Funds
Mutual Fund Fact 5: An ETF (an Exchange-Traded Fund) is a type of mutual fund (2014 Investment Company Fact Book)
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