Money Market Funds

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Last Updated:September 23, 2023

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What Is a Money Market Fund?

Money market funds, or MMFs, are a form of open-ended mutual fund that invests in money market short-term securities (1-year limit, average duration of 120 days).

Treasury bills, commercial papers, bank certificates of deposit, banker's acceptance bills, short-term government bonds, corporate bonds, and other short-term securities account for most of an MMF's holdings.

Dividend reinvestment is the only mechanism to distribute dividends in MMF. Each unit is usually kept at $1, and any income that exceeds $1 is automatically converted into fund shares regularly. The more fund shares you have, the more assets you have.

In contrast, other open-end funds have fixed shares and accumulate unit net worth. Generally, the fund's quarterly/annual payouts are investors' only source of income.

Key Takeaways

Money market funds invest in short-term, low-risk securities like Treasury bills and commercial paper to provide higher returns than savings accounts with low volatility.
Key features are a stable $1 per share price, check-writing abilities, and income reinvestment to grow fund shares rather than net asset value.
Advantages are liquidity, yield, and principal stability, making them a safe cash haven between other investments.
Major types are prime, Treasury, tax-exempt, institutional, and retail money market funds with varying assets and clients.
Money market funds have over $2.6 trillion in assets today, with liquidity and regulation as current focuses after 2008's financial crisis.

Understanding Money Market Funds

This type of fund is also known as a Money Market Mutual Fund (MMMF). This is a collection of funds from numerous small investors managed by fund managers who execute market activities.

After earning income, the revenue is distributed according to period length and the number of shares each investor holds.

Mutual funds that mainly operate in the money market are called money market mutual funds. The money market mutual fund is a unique sort of mutual fund that has been around since the 1970s when it began as a new investment and financial management instrument.

Money market mutual fund managers utilize investors' funds to enter into positions in profitable short-term money market instruments such as Treasury bills and commercial paper. These funds are acquired after a buyer purchases several fund shares at a fixed price (typically $1).

Furthermore, buyers can write checks for the funds they own in the form of fund shares.

Money Market Funds Characteristics

MMF has the following characteristics:

1. The fundamental distinction between MMFs and other stock-investing funds is that the net asset value of each fund unit is fixed, usually at $1.

2. Investors can reinvest their income after putting money in the fund, and their investment income will continue to grow, increasing the number of fund shares they hold.

For example, a $100 investment in a money market fund entitles the investor to 100 fund units. If the investment return is 8% after one year, the investor will get an additional eight fund units for 108 fund units, or $108.

3. The rate of return is the standard by which MMFs are measured, as opposed to other funds that earn profit by raising the value of their net assets.

4. The money market is low risk with high liquidity. Additionally, investors can transfer fund units at any moment to meet their demands, regardless of the fund's expiration date.

5. The average maturity of a MMF investment portfolio is 4 to 6 months. Thus, the risk is low, and the price is usually solely influenced by interest rates.

6. It has low investment costs. These don't usually charge redemption fees, and their administration costs are also cheap.

MMFs charge yearly management fees of 0.25% to 1%of the fund's net asset value, which is lower than traditional funds' annual management fees of 1 percent to 2.5 percent.

7. It is open-ended. The funds are generally considered risk-free or low-risk investment vehicles suitable for short-term capital investment to earn interest.

8. It is particularly suitable when interest rates are high, inflation is high, securities liquidity is declining, and credibility is eroded. It is relatively well-guarded against loss.

Advantage and Features of Money Market Funds

Money market funds have various advantages, such as utilizing fund accounts to issue checks and pay consumer bills, reliable income, excellent liquidity, low purchase limits, and high capital security; it is typically used temporarily before making fresh investments.

MMFs are a haven for cash; they earn more excellent rates than demand deposits and can be withdrawn at any moment for alternative investments.

Some investors buy significant amounts of money market fund shares and then gradually redeem them to invest in stocks, bonds, and other funds. Many investors also keep cash in money market funds for emergencies. Some MMFs even allow investors to withdraw funds directly through ATMs.

MMF has the following investment features:

1. Invested in a high-quality portfolio of securities in the money market

2. Offer a limited deposit account.

3. Subject to relatively few regulatory constraints

Overall, it will provide a higher rate of return than depositing funds directly into a bank's savings account. Although its yield is smaller than other funds or stocks, it is a decent alternative for investors who do not want to take on too much risk in exchange for a high return.

Money Market Funds History

Bruce Roger Bent and Henry Bedinger Rust Brown founded the first money market fund in 1971. It was known as the Reserve Fund and was available to investors who wanted to keep their money safe while earning a small return.

Several other funds were quickly established, and the market exploded over the next few years. As a result, MMF is credited with bringing mutual funds into the mainstream, which had previously been underutilized.

Regulation Q, which, at the time, barred demand deposit accounts from earning interest and capped interest rates on other types of bank accounts at 5.25 percent, was overcome by MMFs in the United States. As a result, it was developed as an alternative to bank accounts.

Bank interest rates in Japan were near zero for a long time during the 1990s. So instead of bank deposits, investors turned towards it for short-term deposits in pursuit of greater yields.

However, due to the bankruptcy of Enron, in which several Japanese funds had invested, several MMFs fell short of their stable value in 2001, and investors fled to government-insured bank accounts. As a result, the total value of money markets in Japan has remained low since then.

MMFs in Europe have always had lesser investment capital than MMFs in the United States or Japan. Moreover, despite the benefits, EU regulations have always encouraged investors to use banks for short-term deposits.

Types of Money Market Funds

From their inception in the 1970s, we all know that MMFs have always been a handy and practical financial tool for various investors.

Whether you want to earn a greater return but don't want to put it in a savings account or you don't have the stomach for the stock market's high volatility, money market funds have always been a great investment option.

Now, we'll look at various types of money funds. You might be thinking, “what? There are various types of funds in this category?” Yes, the financial world has always been fascinating!

There are different types of money funds in the current money market. Money funds are classified by their investing strategy:

1. Prime money fund

Prime money funds invest primarily in variable-rate debt and commercial paper issued by firms, as well as government and agency securities in the United States.

Any money fund that isn't classified as a Treasury or a tax-exempt fund can be considered a prime money fund. Here is the overview of the J.P. Morgan Prime Money Market Fund.

“ The Fund seeks current income while seeking to maintain liquidity and low principal volatility.

The Fund will comply with SEC rules applicable to all MMFs, including Rule 2a-7 under the Investment Company Act of 1940.

The Fund invests in high-quality, short-term obligations that present minimal credit risk, including 1) Securities issued by the U.S. government and its agencies, 2) Floating rate and variable rate demand notes of U.S. and foreign corporations, 3) Commercial paper - in the highest category by Moody's Investor Services (P1) and Standard & Poor's (A1) 4) Certificates of Deposit and time deposits 5) Asset-backed securities 6) Repurchase agreements.”

2. Treasury, or Tax-exempt

A government money fund invests at least 99.5 percent of its total assets in cash, government securities, and fully collateralized repurchase agreements (i.e., collateralized by cash or government securities).

A Treasury fund invests in Treasury bills, bonds, and notes and is a government MMF. Here is an overview of Vanguard Treasury Money Market Fund (VUSXX)

Tax-exempt money fund primarily invests in state and local government obligations (sometimes known as "municipal securities") that are tax-free principally in the United States (and, to some extent, state income taxes). Here is an overview of Vanguard Municipal Money Market Fund (VMSXX)

3. Institutional money fund

Institutional money funds are low-cost share classes with a significant minimum investment sold to corporations, governments, and fiduciaries. They're frequently set up, so money from a company's primary operational accounts gets swept to them overnight.

Large national chains frequently maintain numerous accounts with banks throughout the country but electronically transfer most of their funds to a concentrated MMF.

4. Retail money fund

Individuals are the primary beneficiaries of retail money funds. Retail MMFs hold approximately 33% of all MMF assets.

Fund yields are typically somewhat higher than bank savings accounts, but these are different products with differing risks (e.g., money fund accounts are not insured and are not deposit accounts).

Retail funds have higher service demands and, as a result, higher expenses than institutional funds; hence their yields are often lower.

The definition of a retail money fund has been 'enhanced' by SEC rule revisions announced on July 24, 2014, to be one that has rules and procedures reasonably designed to confine its shareholders to natural persons.

Money Market Funds Size

These have always had a tremendous amount of capital, not only because of the investments an MMF makes but also because shares are easy to trade.

The following are the most recent breakdown of the $2.6 trillion total net assets for the U.S. fund industry: $1.4 trillion in prime money funds, $907 billion in Treasury money funds, and $257 billion in tax-exempt money funds. Institutional assets outnumber retail assets by around 2:1.

The JPMorgan Prime Money Market Fund has over $100 billion in assets and is the largest institutional MMF. BlackRock, Western Asset, Federated Investors, Bank of America, Dreyfus, AIM, and Evergreen are among the largest providers of institutional money funds (Wachovia).

The Vanguard Federal Money Market Fund (Nasdaq: VMFXX) is the largest mutual Fund with over US$120 billion in assets. Fidelity, Vanguard, and Schwab are the three largest retail money fund, providers.

Money Market Funds in the present day

Liquidity has become a significant issue. Even financial instruments like certificates of deposit issued by creditworthy institutions (typically totally liquid) have become difficult to trade.

The Federal Reserve in the United States has indicated that Section 2a-7 (Treasury-style) MMFs can help address cash outflows, especially if they are abnormally substantial.

The Bank of England has pledged to provide comparable services, and the European Central Bank is expected to follow suit. A deposit insurance scheme similar to that for ordinary investors, bank deposits, is another option to back up the money.

Most funds increased their overnight liquidity in late September 2008 as a defensive measure, further disrupting the interbank market and widening the gap between the overnight and LIBOR rates.

This approach, however, comes at the expense of fund performance, particularly for those with a higher proportion of illiquid securities funds, such as floating rate bonds and commercial paper.

When interest rates fall, MMFs are usually the most competitive. As a result, the United States and Europe authorities will examine whether and how these funds should be managed.

However, expect funds to be managed and operated more cautiously while focusing on this issue.