Advantages of Money Market Funds Compared to Growth Funds
Money market mutual funds are a primary source of liquidity for corporations, pension funds and individuals. Growth funds seek to outperform the comparable index. Deciding which investment is appropriate depends on your investment objectives and risk profile.
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Background
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Money market funds as well as growth funds are managed by mutual fund companies, which charge a management fee to create a portfolio of securities. Money market funds are cash equivalents and purchase only short-term, safe securities. Growth funds by contrast invest in longer-term securities such as stocks, bonds and even real estate.
Money Market Funds
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There are five types of money market funds to consider. Prime funds invest in commercial paper, repurchase agreements and treasuries; government funds invest in treasuries or government agency securities; treasury funds invest in U.S. Treasuries; tax-free funds invest in municipal securities not subject to taxation; and off-shore funds invest in short-term fixed-income investments overseas.
Prime funds will almost always offer the highest yield but also carry more risk, simply because they invest in private corporations that may go out of business. The next highest yield comes from government funds because government agency debt carries more risk than that of the federal government. Last is Treasury funds, because Treasury debt is guaranteed by the federal government.
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Growth Funds
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Growth funds are another asset class that offers the potential of far greater returns than money market funds but also carry much more risk. The three important statistical measures to consider when analyzing growth funds are beta, standard deviation and alpha. Beta represents the funds risk as compared with the overall market. Standard deviation is the funds volatility. A greater standard deviation means a greater upside and downside for the fund. Alpha is the measure of additional return that the manager contributes. This is a valuable statistic to use in selecting which growth fund in which you may choose to invest.
Significance
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Money market funds play an important role in managing finances and providing liquidity to investment markets. They offer many advantages over growth funds. These include liquidity, safety and consistent returns. However, these advantages do not come without disadvantages. Growth funds can outperform money market funds by dozens of percentage points over various time periods. For most investors the proper choice is not to invest in either money funds or growth funds but to create a proper asset allocation that includes both.
Considerations
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Look closely at the instruments in which the fund invests; these are typically posted on the website of the fund company. When considering the the proper growth fund investment, research is critical. There are thousands of funds, each with its own risk attributes, including beta, standard deviation and alpha. These are not applicable to money funds but should be considered carefully in growth funds because of the potential loss of your investment.
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