The crisis at Silicon Valley Bank caused a lot of people to look closely at their bank accounts. Some moved money to banks that were larger or safer. Others decided it was time to get some yield, so they moved their money out of banks entirely.
Many of those savers opted for money market mutual funds, which usually pay higher interest than bank accounts yet are a little less risky than other investments. In fact, overall balances in money market funds reached $5.4 trillion in mid-March, the highest ever. According to Morningstar analysts, $363 billion of that influx arrived in that month alone. The effect was so pronounced that US Treasury Secretary Janet Yellen noted it as a potential source of instability for the financial system.
But what exactly is a money market mutual fund and why are they so appealing? We’ll explain.
What is a money market fund?
A money market fund, also known as a money market mutual fund, is a type of mutual fund that invests in very short-term securities, such as commercial paper or U.S. government bills. These are items that have a maturity of 30 days or less. The idea is that with such short-term maturities, the lender has faith that default will not occur. The return can be substantial: The average yield across the top 100 money market mutual funds is 4.63% as of April 18, according to Crane Data. Savings accounts, on the other hand, have an average APY of 0.24% for the week of April 19, according to Bankrate.
How does a money market mutual fund work?
Money market mutual funds are offered by mutual fund companies and brokerage firms. They often require a minimum account balance, such as $1,000. Like all mutual funds, money market funds pool money from investors and use it to buy securities—in this case, short-term bonds that pay relatively low but steady interest. Money market funds are designed to have a share value of $1.00; if a fund falls below that, it “breaks the buck.” Under normal conditions, the issuing companies allow investors to take money out at any time, and some even give customers ATM or debit cards to use with their money market accounts.
Types of money market funds
Money market funds are classified into three main types, based on their investments:
Government funds invest in US government securities, as well as securities guaranteed by the US government but issued by organizations like Fannie Mae.
Municipal funds invest in municipal money market securities. These have tax advantages for some investors.
Prime funds invest in commercial paper, bank certificates of deposit, and other high-quality short-term debt.
Some money market funds are for large institutional investors such as pensions or endowments; these may require a minimum investment of $10 million or so. There are also money funds that invest in foreign currencies.
In general, money market funds are good places to store short-term savings and to hold money from brokerage transactions, such as stock sales or interest income. The absolute return tends to be low, though, so money market mutual funds are usually not used for retirement or college savings.
Money market funds vs. money market accounts
Many banks offer money market accounts, but these are somewhat different from money market mutual funds. They are federally insured and usually pay lower interest. The chart below summarizes the differences between the two.
Is my money safe in a money market fund?
Money market funds are pretty safe but not perfectly safe. Because the investments are short term, the portfolio managers have a pretty good idea of what’s going to happen to the investments. A big technology company might go bankrupt someday, but will it go bankrupt next week? Probably not.
Money market funds are often seen as being as safe as the similarly named money market accounts at banks, but they are not. These funds are not federally insured, even if they invest in US government securities, and a few money market funds have lost money when the financial markets go haywire. This happened to a few funds in 2008, during the Global Financial Crisis, and again in 2020, at the start of the pandemic. Neither the government nor the industry would like it to happen again, so investors should expect more regulations or more warnings about this risk, especially with the recent popularity of these funds.
Is a money market fund a good choice for you?
As there is slight risk involved, money market mutual funds should not replace standard checking accounts. However, for investors with more than a few thousand dollars in savings, these funds are worth considering as they typically offer higher interest rates than traditional bank savings accounts. They are an important tool for managing investment portfolios and meeting savings goals.
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This article was originally published on SFGate.com and reviewed by Lauren Williamson, who serves as Financial and Home Services Editor for the Hearst E-Commerce team. Email her at firstname.lastname@example.org.