Money Market Vs. Mutual Funds
Money market funds are mutual funds that invest in money market instruments such as certificates of deposit, banker's acceptances, commercial paper, U.S. Treasury bills and federal funds.
Mutual funds, in general, are investment pools that invest according to a specific style for each fund. A municipal bond mutual fund invests in municipal bonds. A Pacific Rim equity mutual fund invests in the common stock of companies that are located in the Pacific Rim region of the World. There are all kinds of mutual funds, and money market funds are simply one type.
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Features
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Money market mutual funds are designed to be safe places to hold money and, as such, are the lowest yielding of all mutual funds. Some money market mutual funds are particularly conservative and invest only in federal funds and U.S. Treasury bills. These are considered the safest, are rated AAA, and pay the lowest interest rate, which can be as low as a fraction of a percent. Other money market mutual funds may take on more risk in order to pay higher rates, but the higher rates may be only a few basis points higher than those of the most conservative funds.
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Function
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Most banks and brokerage firms offer money market funds as a safe place to keep small or even large amounts of money until you buy another investment or use the money in some other way. Although a money market fund is not FDIC-insured, if it invests in FDIC-insured bank certificates of deposit, the portion of its total portfolio that is invested in those CDs will be safe.
Safety
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The point of investing in money market mutual funds is to keep your money in a safe place, without having to worry about whether your money is covered by FDIC insurance. The safety is thought to come from the investment profile of high-quality investments with very short-term maturities that are held in the fund. That notion of safety was shaken when one of the largest money market mutual funds, the Reserve Fund, lost money during the financial crisis of 2008. That was the first time such a thing had happened in a major money market mutual fund, and only the second time it had happened since 1970 when money market mutual funds were invented. The reason was its investment in Lehman Brothers commercial paper, which, although highly rated when it was purchased, became worthless when Lehman Brothers went out of business. Nevertheless, money market mutual funds are still considered a safe investment, particularly if they follow a conservative investment philosophy and invest only in fed funds and Treasury bills.
Mutual Funds
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If you have a longer investment time horizon than less than one year, you can find reasonably safe mutual funds that invest in U.S. government bonds and high-quality corporate bonds. While market fluctuations present the risk of losing money, if you don't need to withdraw your principal and are just looking for a higher yield than money market funds will provide, you might want to consider these types of funds, which invest in longer-term maturities.
Money Market Accounts
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Banks have money market accounts (MMA) that are a type of savings account and are FDIC-insured. They are not considered mutual funds. Unlike in money market mutual funds, you are limited in an MMA in the number of withdrawals you can make in a year, but both kinds of investments have minimum deposits. Normally a money market mutual fund will yield slightly more than an MMA, but you should check the fees that may be associated with the mutual fund, because in periods of low interest rates they may be higher than what you earn in interest. In any case, fees will lower the return on your investment. Many money market mutual funds have no fees.
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