Money market funds are short-term fixed-income mutual funds that invest in high-quality, low-duration debt instruments. These funds are structured to offer liquidity, capital preservation, and modest income by holding assets such as U.S. Treasury bills, certificates of deposit, repurchase agreements, and commercial paper from companies with strong credit ratings. Because of their conservative investment mandate, money market funds are used primarily as cash equivalents.
Unlike bank savings accounts or certificates of deposit, money market funds are not insured by the Federal Deposit Insurance Corporation (FDIC). However, they are regulated under Rule 2a-7 of the Investment Company Act of 1940, which places strict limits on maturity, credit quality, and portfolio diversification. These regulations aim to maintain a stable net asset value (NAV), typically set at $1.00 per share.
Use cases and appeal
Money market funds serve several roles in an investor’s portfolio. They are commonly used to park cash temporarily between investment decisions, serve as a holding place for distributions, or act as a cash allocation within larger investment strategies. For institutions and retail investors alike, these funds provide daily liquidity without forcing the investor to sacrifice all yield.
Brokerage accounts often sweep idle cash into affiliated money market funds. Retirement plans may include a stable value or money market fund as a capital preservation option. While yields are typically low compared to longer-duration bond funds or equities, they move more closely with short-term interest rates set by the Federal Reserve, offering some responsiveness to changes in the rate environment.
Risk profile
Money market funds are not risk-free, though they are considered among the lowest-risk investment options available in the market. The primary risks are credit risk—if an issuer defaults—and liquidity risk, if the fund cannot meet redemptions due to market stress. That said, money market funds are built to minimize these risks through diversification, short maturity holdings, and restrictions on the types of debt they can hold.
During the 2008 financial crisis, one major institutional money market fund broke the buck—meaning its NAV dropped below $1.00 due to exposure to a defaulted security. This event caused a run on money market funds, triggering government support and eventual regulatory reforms. Since then, oversight has tightened, and new rules require funds to maintain higher levels of liquidity and transparency.
Retail money market funds are generally safer than institutional ones because they are more restricted in what they can hold. Government money market funds, which invest primarily in U.S. Treasury and agency securities, offer the highest safety level among the category, though with the lowest yields.
Yield and returns
Yields on money market funds are tied closely to short-term interest rates. When the Federal Reserve raises or lowers the federal funds rate, money market fund yields typically adjust in the same direction. This makes them more responsive to interest rate changes than longer-term bond funds, which may lose value when rates rise.
However, yields are still modest. Money market funds prioritize capital preservation and liquidity, not growth. In low-rate environments, after inflation and taxes, real returns may be negative. In higher-rate periods, yields improve, making them a more appealing alternative to bank savings accounts or short-term CDs.
Unlike individual bonds, which offer fixed coupons and maturity dates, money market fund income fluctuates with changes in the market. Distributions are generally paid monthly and can be reinvested automatically. Investors tracking fund performance should focus on yield rather than capital appreciation, as the NAV is designed to remain stable.
Tax considerations
Interest from money market funds is taxed as ordinary income at the investor’s federal and potentially state tax rate, unless the fund holds tax-exempt securities. Tax-exempt money market funds invest in short-term municipal securities and are generally suitable for investors in higher tax brackets who want to shelter income from federal taxes.
Investors using money market funds in taxable brokerage accounts should factor in tax efficiency relative to after-tax yields on alternatives such as Treasury bills or municipal bonds. In tax-advantaged accounts like IRAs, taxes on interest income are deferred, making taxable and tax-exempt funds effectively equivalent in those settings.
Comparison to other short-term options
Money market funds are often compared to high-yield savings accounts, Treasury bills, or short-term bond funds. Each has advantages and limitations. High-yield savings accounts may offer similar yields with FDIC insurance, but typically have more transfer restrictions. Treasury bills provide safety and predictability but lack daily liquidity unless sold early. Short-term bond funds may offer slightly higher yields but can fluctuate in value more than money market funds, especially in volatile markets.
Because of their liquidity and ease of access, money market funds are often used as a default cash holding vehicle in brokerage platforms. For investors seeking low-volatility options with better liquidity than most fixed-term securities, they serve a practical role.
Liquidity and accessibility
One of the key features of money market funds is immediate access to cash. Shares can typically be redeemed at any time at a stable $1.00 NAV. Most funds also allow check-writing privileges, wire transfers, or direct deposits, offering more utility than a standard brokerage account balance.
That liquidity makes them especially useful in times of uncertainty or for portfolios with anticipated short-term cash needs. However, regulations now allow retail money market funds to impose redemption gates or fees during periods of extreme stress to maintain stability. These mechanisms are rare but worth understanding if you rely heavily on a fund for cash flow management.
Choosing a money market fund
When evaluating money market funds, investors should consider the fund’s type—government, prime, or tax-exempt—as well as its expense ratio, yield, and sponsor quality. Large, well-established fund families generally offer tighter spreads, lower fees, and stronger operational support. Expense ratios on many money market funds have been compressed over the years, with competitive options available below 0.25%.
Yields vary based on fund type and market conditions. Government money market funds tend to yield less than prime funds, but with lower credit risk. Tax-exempt funds may offer lower yields upfront but could deliver higher after-tax income depending on the investor’s bracket. Reviewing the fund’s holdings, historical stability, and fee structure is necessary even for these seemingly simple products.
A list of no-load money market funds, along with guidance on where they fit in broader investment strategies, is available on the main page.