What is a Prime Money Market Fund?

Prime money market funds provide a way to invest money and earn a monthly dividend. Compared to money market accounts offered by banks, prime money market funds offered by mutual fund companies have a slightly higher rate of return, and you can access your prime money market cash at any time without penalty. This liquidity and flexibility is attractive to both new and seasoned investors.

When you and other shareholders pool your money in a prime money market fund, the fund's managers use the collective balance to purchase short-term securities. Because prime money market funds look for quality, they typically hold a high percentage of highly rated government bonds and a very small percentage of corporate bonds or certificates of deposit. For example, the prime money market run by mutual fund giant Vanguard holds more than 80 percent of its assets in U.S. government-related bond and debt instruments.

Prime money market funds attempt to keep the value of each share at $1. This means that when you invest $5,000 in a prime money market fund, you receive 5,000 shares; as time goes on, your principal balance grows as you receive interest payments. As dividend payments are added to your account, your balance will continue to equal $1 per share you own.

While bank money market accounts are insured under the Federal Deposit Insurance Corp., prime money market funds offered by mutual fund companies do not have this protection. If a mutual fund holding your prime money market account goes bankrupt, you will lose your investment. However, money market funds are regulated by the U.S. Securities and Exchange Commission, and the largest U.S. mutual fund firms are in little danger of going bankrupt; "Forbes" reports that holding a prime money market with a large fund firm is a safe investment.

Opening a prime money market fund account often requires an initial investment of $1,000 to $3,000, and these funds typically require you to maintain a minimum balance in your account. Depending on their individual regulations regarding prime money market accounts, fund firms can charge a fee when your balance falls below the minimum required.

Prime money market funds carry annual expenses to pay for administrative and operating costs. These expenses are expressed as ratios, and the lower the expense ratio, the less fund managers extract from the total assets at the end of the year. Expense ratios for these funds hover in the range of 0.2 to 0.5 percent.

Most prime money market funds allow you to write checks against your balance, but they usually require checks be written for a minimum amount. This rule discourages shareholders from using a prime money market fund like a regular checking account.