Money Market Fund

What Is a Money Market Fund?

A money market fund is a mutual fund that invests in high-quality, short-term debt instruments, cash, and cash equivalents. It’s designed to provide high liquidity and low risk while generating modest income. Unlike bank deposit accounts, money market funds are investment products and are not FDIC‑insured.

Key points
* Invests in short-term, liquid instruments (Treasury bills, commercial paper, CDs, repurchase agreements, bankers’ acceptances).
* Aims to maintain a stable net asset value (NAV) of $1 per share (some institutional funds may float).
* Provides low risk, high liquidity, and modest income but little to no capital appreciation.
* Not FDIC-insured; brokerage accounts holding them may have SIPC protection against broker failure, not against investment losses.

How Money Market Funds Work

• Structure: Investors buy redeemable shares. The fund pools cash and invests in many short-term, highly rated debt instruments.
• Typical holdings: U.S. Treasuries, repurchase agreements, commercial paper, certificates of deposit, bankers’ acceptances.
• NAV target: Retail and many government funds aim to keep NAV at $1 per share; earnings are paid out as dividends.
• Liquidity rules: Shareholders can typically redeem shares at any time, although funds may limit the number of redemptions or impose temporary restrictions in stressed conditions.
• Returns: Driven by short-term interest rates; returns rise and fall with money market rates.

“Breaking the Buck”

If a fund’s NAV falls below $1 per share it is said to have “broken the buck.” This typically results from large losses, rapid redemptions, or extreme market stress. Notable examples:
* 1994 — Community Bankers U.S. Government Money Market Fund liquidated after dropping to $0.96.
* 2008 — Reserve Primary Fund fell to $0.97 after holding Lehman Brothers debt, triggering widespread redemptions and regulatory response.

Types of Money Market Funds

• Prime money market funds: Invest in corporate and non‑Treasury short-term debt (commercial paper, floating-rate notes).
• Government money market funds: Invest primarily in U.S. government securities and fully collateralized repurchase agreements.
• Treasury funds: A subset focusing on U.S. Treasury securities.
• Tax-exempt (municipal) money market funds: Invest in short-term municipal debt; earnings may be exempt from federal—and sometimes state—income tax.
• Institutional vs. retail: Institutional funds often have higher minimums and may be structured differently (e.g., floating NAV for some institutional prime funds).

Regulation and Risk Controls

U.S. money market funds are regulated by the Securities and Exchange Commission (SEC). Key regulatory limits include:
* Weighted average maturity (WAM): Portfolio WAM generally limited to 60 days to keep holdings short and liquid.
* Quality and concentration: Funds must invest in high-credit-quality instruments and have limits on exposure to a single issuer (with some exceptions for government securities).
* Post‑2008 reforms: Introduced more restrictive portfolio rules, tools such as liquidity fees and redemption gates, and—later—requirements that certain institutional prime funds adopt a floating NAV to reduce run risk.

Advantages and Disadvantages

Pros
* Very low perceived risk relative to other mutual funds.
* High liquidity — suitable for parking cash or managing short-term needs.
* Generally higher yields than basic savings accounts (depending on rates).
* No sales loads in many cases.

Cons
* Not FDIC-insured; principal can lose value in extreme situations.
* Little to no capital appreciation — returns are modest.
* Sensitive to short-term interest rate changes and monetary policy.
* Institutional prime funds may float NAV or impose temporary restrictions in stress scenarios.

Brief History and Evolution

Money market funds emerged in the early 1970s as a higher‑yield alternative to bank deposits. Over time they shifted from primarily government securities to include commercial paper and other short-term corporate instruments, increasing yields but adding exposure. The Reserve Primary Fund failure in 2008 and broader market stress led the SEC to tighten rules in 2010 and to adopt additional reforms in 2016 (including floating NAV requirements for certain institutional funds).

Money Market Fund vs. Money Market Account (MMA)

• Money market fund: An investment product offered by fund companies and brokerages. Not FDIC‑insured, subject to market risk.
• Money market account: A bank deposit product insured by the FDIC (up to limits). Typically offers check-writing or debit privileges but may limit transactions.

When to Use a Money Market Fund

• Short-term cash parking between investments.
• Emergency cash buffer that needs to be accessible.
• A conservative place to hold proceeds from a sale while deciding where to deploy capital.

Common Questions

Is money in a money market fund safe?
* Generally low risk, but not risk‑free. Funds can lose value in extreme conditions and are not FDIC-insured. Brokerage accounts may have SIPC protection against broker failure, not investment losses.

Can money market funds lose money?
* Yes—although rare, funds have broken the buck during severe market stress.

Are money market funds good long-term investments?
* No. They are intended for short-term liquidity and capital preservation, not long-term growth.

Conclusion

Money market funds offer a liquid, low‑risk way to earn modest income on short-term cash. They are useful for short-term parking of funds and cash management but are not substitutes for insured bank deposits or long-term growth investments. Regulatory reforms since 2008 have strengthened their resilience, but investors should still understand the distinctions between fund types and the limits of protection.