Money market funds are getting more popular today among investors because of its relative safety. However, there are also disadvantages you need to know before you park your money in them. Read on and learn more!
What is a Money Market Fund?
A money market fund is a fund that invests in cash and cash equivalent. Such instruments are very liquid short-term investment. Among these are:
- Certificates of Deposit (CDs)
- Commercial Paper
- US Treasuries
- Bankers’ Acceptances
- Repurchase Agreement
Money Market Funds vs. Money Market Accounts
Fund companies sponsor money market funds and they carry no guarantee of principal. Meanwhile, money market accounts are savings accounts that financial institutions offer. MMAs have limited transaction privileges and they avail the insurance of the FDIC.
MMAs limit the accessibility of account balances via check writing. Meanwhile, money market fund withdrawals are generally available on demand.
For MMAs, bank may allow up to six withdrawals per statement cycle. Others do not have any check-writing at all.
Advantages of Money Market Funds
In other words, you can park your money in these accounts if you’re still unsure where to put your investment.
Money market funds are less risky if you compare them with stocks and bonds. These funds invest in low-risk vehicles like certificates of deposit (CDs), T-bills, and short-term commercial paper.
Low Initial Investment
Money market securities usually have large minimum purchase requirement. That means a vast majority of retail investors couldn’t buy them. Money market funds have lower requirements, allowing investors to avail it at lower costs.
These funds don’t invest in illiquid assets. They choose securities that have high demand and thus are more liquid, meaning you can easily buy and sell them.
For their clients, brokerage firms typically use money market mutual fund to give cash management services.
That means your money will earn an extra percentage point in annual returns higher than those other possible investments.
Disadvantages of Money Market Funds
May Weaken Purchasing Power
If inflation rises much faster than your return in the money market account, you are losing purchasing power.
Expenses May Accumulate
Small annual fees can accumulate and eat away at your profit, especially when you’re only earning 2 or 3 percent in the account. As a result, it’s even more difficult for your money to keep up with inflation.
No FDIC Protection
The Federal Deposit Insurance Corporation (FDIC) insures money funds for up to $100,000 per depositor. But money market funds do not usually receive this kind of insurance.
If you’re investing long-term for a retirement fund, you wouldn’t want money market funds. Generally, these funds whip out returns only slightly higher than the inflation rate. It’s better to use money market funds as temporary parking spaces for expected cash outlay.