Learn how money market funds work, their types, pros and cons, and how they compare to savings accounts. Explore money market mutual funds with Vanguard.
What are money market funds and how do they work?
Key Insights
- Money market funds invest in short-term, high-quality debt securities to provide stability and liquidity.
- They’re not FDIC insured but are regulated to maintain a stable net asset value.
- Money market fund rates fluctuate based on interest rates, Federal Reserve policy, and fund type.
- Money market funds differ from high-yield savings accounts, which are bank deposit accounts insured by the FDIC.
- They’re ideal for emergency funds, short-term savings, and settlement funds, but not for long-term growth.
What is a money market fund?
Money market funds are a type of mutual fund that invests in low-risk, short-term debt securities, such as Treasury bills, municipal debt, or corporate bonds. They’re designed to offer a safe, stable investment option for money you may need to access in the short term, like an emergency fund or savings for a short-term goal.
Money market funds are different from money market accounts in a few ways. While both are low-risk options for saving money and earning modest returns, money market accounts are typically offered by banks and credit unions, and as deposit accounts, they’re insured by the FDIC, the federal agency that insures bank deposits in the U.S. Money market funds are an investment product, so you need a brokerage account to get started. They can be a valuable tool for diversifying your portfolio, allowing you to earn dividends on your savings while helping reduce market risk.
Put your cash to work in a money market fund
Money market funds can be a sound alternative to traditional bank accounts or certificates of deposit (CDs). Relative to these products, they generally combine competitive yields with easy access to your money and low risk.
Money market funds are typically used to hold:
- Money you’ll need soon, whether it’s for an upcoming purchase or part of a spending fund.
- Money that’s part of an emergency fund—i.e., you have no plans to spend it, but it needs to remain safe and accessible.
Money market funds generally pay a higher yield than traditional bank savings accounts.1 And it’s easy to withdraw money from a money market fund without the fees or penalties you might pay with a CD.
Money market funds are also used as settlement funds—accounts that hold the money used to buy and sell securities in brokerage accounts. At Vanguard, we use Vanguard Federal Money Market Fund (VMFXX) as one of our settlement fund options.*
Explore our selection of money market funds designed to help you manage your short-term cash
How do money market funds work?
Money market funds invest in low-risk assets like Treasury bonds, CDs, or short-term, high-quality corporate bonds with maturities of less than a year.
Unlike stock or bond funds, they have a fixed price of $1 per share2 —and money market funds aim to maintain their net asset value (NAV). That means your account value shouldn’t change other than any growth from your earnings.
While all money market funds have the same share price, their yields vary. To see what a money market fund is currently paying, look at the 7-day yield.3 This calculation is used to measure a fund’s annualized yield. It gives you an idea of the return you can expect over the next year, based on the average payouts made in a week. This makes it helpful for comparing different money market funds.
For example, a $10,000 investment in a money market fund with a 5% SEC yield would earn $500 on an annual basis (10,000 x 0.05). Details vary by fund and fund provider, but money market funds typically pay distributions monthly.
What are the types of money market funds?
Money market funds are classified in 2 main ways: by who can invest in them (retail versus institutional) and by the types of securities they hold (taxable versus tax-exempt). Understanding these classifications can help you choose the fund that best fits your investment profile and tax situation.
Retail versus institutional money market funds
The first distinction is between retail and institutional money market funds, which determines who the intended investor is and how the fund’s net asset value (NAV) is calculated.
Retail money market funds are designed for individual investors and can maintain a stable $1 NAV per share. Institutional money market funds serve larger investors like corporations, pension funds, and institutional accounts, and are required to use a floating NAV that fluctuates with market conditions.
Taxable versus tax-exempt funds
Money market funds are also categorized by 2 main tax categories: taxable and tax-exempt.
Taxable money market funds generate income that’s subject to federal income tax. These include both government money market funds (covered in detail below) and prime money market funds. Prime funds invest in high-quality, short-term corporate and bank debt issued by U.S. and international entities, and typically offer higher yields than government funds.
Tax-exempt money market funds (commonly called municipal funds) invest in short-term municipal bonds. While they usually offer lower yields than taxable funds, their earnings are federally tax free. Some tax-exempt funds invest only in bonds issued by a specific state, which makes them both federal and state tax free for residents of that state.
Government money market funds
Government money market funds invest primarily in U.S. government securities, including Treasury bills, Treasury notes, and repurchase agreements backed by government securities.
These funds are considered among the safest money market options because they invest in debt backed by the full faith and credit of the U.S. government. They typically offer lower yields than other money market funds but provide high liquidity and security.
Government money market funds can use either a stable or floating NAV but don’t technically carry the retail or institutional designation, though most buyers of government money market funds tend to be retail investors.
Money market fund rates
Money market fund rates are commonly expressed as the 7-day SEC yield, which reflects the annualized income earned by the fund over the past 7 days, after expenses. These rates fluctuate based on prevailing interest rates, Federal Reserve policy decisions, and the types of securities held by the fund. For example, when the Fed raises rates, money market fund yields generally increase, and vice versa. It’s important to be aware that money market fund rates can change frequently and may not always keep pace with inflation.
Money market fund versus high yield savings account
Both money market funds and high-yield savings accounts are popular choices for short-term cash savings, but they differ in a few ways. A money market fund is an investment product that pools money to buy short-term debt securities, while a high-yield savings account is a bank deposit account insured by the FDIC. Savings accounts offer principal protection backed by the bank, whereas money market funds are not FDIC insured but are regulated to maintain stability.
There are a variety of savings options available to suit your needs, including brokered CDs and the Vanguard Cash Plus Account.
Curious how money market funds and other investments can fit into your tax planning strategy?
Pros and cons of money market funds
Pros of money market funds
- Liquidity. Money market funds allow easy access to your money, often with same-day availability.
- Safety. They invest in high-quality, short-term securities to minimize risk.
- Stability. They aim to maintain a stable net asset value, typically $1 per share.
- Diversification. They spread investments across many securities to reduce risk.
- Potentially higher yields. Depending on market conditions, they may have higher yields than traditional savings accounts.
Cons of money market funds
- Lower returns. They generally offer lower returns compared with other investment options.
- Inflation risk. Returns can be affected by inflation over time, potentially reducing purchasing power.
- Lack of FDIC insurance. They’re not FDIC-insured, unlike some bank savings accounts or savings account alternatives like the Vanguard Cash Plus Account.
- Variable yields. Yields may change as interest rates rise or fall, leading to variable income.
- Limited growth potential. They focus on stability and liquidity rather than capital appreciation.
When to use money market funds
- Emergency funds. Keep cash accessible for unexpected expenses.
- Short-term savings. Park money temporarily while planning for future investments.
- Settlement funds. Hold proceeds from sales before reinvesting.
- Cash reserves. Maintain liquidity for upcoming payments or purchases.
Note: They’re not ideal for long-term growth or retirement savings due to limited return potential. You should also avoid using money market funds for goals requiring significant capital appreciation.
Start putting your cash to work in a money market fund
Frequently asked questions about money market funds
A money market mutual fund is a type of mutual fund that invests in short-term, high-quality debt securities such as Treasury bills, commercial paper, and certificates of deposit. These funds seek to provide investors with a safe, liquid investment option that offers income while preserving capital. Money market mutual funds are regulated by the SEC and aim to maintain a stable net asset value, making them a popular choice for investors looking to manage short-term cash needs.
Money market accounts are bank accounts that invest in assets like those in money market funds. They have different insurance coverage and may have different fees, withdrawal restrictions, yields, minimums, and features.
Money market funds are intended to be as safe as possible, but like all investments, they’re not risk free. The price of a money market fund share has dropped below $1 only twice in history, and that was before additional regulations were put in place in 2016 to make them even safer. (Both of these funds were prime funds.)
Of all types of money market funds, government funds can be considered the safest. At least 99.5% of their assets are backed by the full faith and credit of the U.S. government.
No, money market funds aren’t insured by the Federal Deposit Insurance Corporation (FDIC). Unlike bank savings accounts, they’re investment products regulated by the Securities and Exchange Commission (SEC). While they aim to maintain a stable net asset value, there’s no government guarantee of principal.
While money market funds are designed to be low risk and maintain a stable net asset value, it’s possible to lose money. In rare cases, if the fund’s investments decline in value or the fund “breaks the buck,” investors could lose principal. However, such events are uncommon due to strict regulations and conservative investment strategies.
The earnings from money market funds can come from dividend income or capital gains, so they’re taxed the same way as other investment income.