Definition of Money Market Funds

History

Bruce R. Bent established the first money market mutual fund in the United States in 1971 by offering his Reserve Fund to people interested in earning a bit more interest than the banks paid while still preserving capital. Three years earlier, Conta Garantia was started by John Oswin Schroy and it included small denominations of commercial paper in addition to federally-issued debt.

Frequently, corporations and banks will offer their excess cash to money market mutual funds in the form of commercial paper or repurchase agreements as so-called "near cash." Or companies will "sweep" their overnight cash balances to money market mutual funds to make extra money. The net yield to the money market mutual fund is slightly higher than if they only invested in obligations of the federal government or if they kept the money in cash. That is the main reason why they are popular.

In December of 2008, there were almost 2,000 money market funds in the US with assets of almost $3.8 trillion. Of those funds, about $2.5 trillion was held for institutions and of which more than 93 percent was tax-exempt. The remainder are retail money market funds that are held by individuals. They are primarily used as a place to warehouse funds for ultimate investment at brokerage firms like Vanguard, Fidelity or Charles Schwab. Banks across the country also offer money market funds, and the investor has the added advantage of being insured by FDIC, even though they receive somewhat less interest.

There are several types of money market funds. The most safe are those that only invest in Treasuries, and they pay the smallest return. Then there are those invested in debt of other agencies of the federal government, followed by those invested in commercial paper issued by some of the country's more highly regarded companies. All of them say they are of the highest quality; and unlike bond funds, they never are valued at a price other than $1 per share regardless of what may happen to interest rates.

While all money market funds say they are safe, you will always run the risk of their "breaking the buck," a term used when their value is less than what was paid for them. That can happen when a company defaults on its commercial paper. However, at no time in history has a money market mutual fund not paid back the full value of an investor's funds, even if it means that the sponsor must dip into its reserves. And an investor in a money fund at a bank can rely on FDIC for coverage in the unlikely event of loss.