Money market funds are a type of mutual fund that invests in high-quality, short-term debt instruments and cash equivalents.
What are money market funds and how do they work?
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 a short-term goal.
Money market funds are different from money market accounts in a few important respects. While both offer low-risk ways to save money and earn 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 interest on your savings while helping reduce market risk.
Put your cash to work
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, along 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—the account holding the money used to buy and sell—in brokerage accounts. At Vanguard, we use Vanguard Federal Money Market Fund (VMFXX) for one option of our settlement funds.
WHY INVEST IN CASH?
Cash investments are designed to offer a low-risk option for investing existing funds, and they may help maximize your savings potential.
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?
Taxable vs. tax-exempt funds
Taxable money market funds, also known as prime money market funds, usually offer higher yields than tax-exempt funds, but any income is subject to taxes. Prime funds invest in corporate and bank debt issued by U.S. and international entities.
Tax-exempt funds (commonly called "munis" or "municipal" funds) usually don't pay as much, but their earnings are federally tax-free, so they can be a better option for investors in a high tax bracket.
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 vs. retail funds
Government money market funds invest only in assets backed by the federal government—for example, Treasury bonds. Because of this government backing, they're considered the safest and most liquid type of money market fund. They often include the words "government fund," "Treasury fund," or "federal fund" in their name.
Retail funds can invest in other types of assets, like municipal bonds or short-term, high-quality corporate bonds. They're sometimes called "prime" funds.
In addition, retail funds are required to follow SEC rules about liquidity fees and gates during times of extreme market stress.4 These rules can mean you'd have to pay a fee or could be temporarily unable to withdraw money if a lot of investors sell shares at the same time.
Government funds are allowed to follow these rules but aren't required to. (Vanguard's government funds don't have fees or gates.)
Pros and cons of money market funds
Money market funds are meant to be:
- Safe. They're intended not to lose value.
- Liquid. You can withdraw your cash at any time without penalties.
- Higher-yielding than savings at traditional banks.
However, depending on what's important to you, you'll need to keep these points in mind:
Insurance coverage. Traditional bank savings accounts and CDs are FDIC-insured up to $250,000. Money market funds aren't insured by the FDIC. Instead, they may be eligible for $500,000 coverage under SIPC when held in a brokerage account.
Accessibility. Because they're mutual funds, money market fund sales are processed like sales of other mutual funds—the trade is processed at the close of business following your trade request, and the money then takes 2 business days to transfer to your bank account. Bottom line, you'll need to allow time for money movement.
All Vanguard money market funds outperformed peer-group averages over every time period.5
Frequently asked questions about money market funds
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 into 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.
While money market funds aren't FDIC-insured, investments held in brokerage accounts (including money market funds) may be insured by SIPC. Unlike FDIC coverage, SIPC coverage doesn't insure the value of your investment—it protects you if your broker fails.
The earnings from money market funds can come from interest income or capital gains, so they're taxed the same way as other investment income.
Money market funds generally have higher yields than bank savings accounts. But savings accounts may have features like overdraft protection.
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.