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What Are Money Market Funds?

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  • Originally Written By: G. Chung
  • Revised By: C. Mitchell
  • Edited By: C. Wilborn
  • Last Modified Date: 11 November 2016
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Money market funds are a type of mutual fund that traditionally have a lower risk and potentially higher reward than most comparable investment and savings vehicles. They typically work by investing money in stable or perceived stable mutual funds, and often require a minimum time frame for investment. Investors who aren’t looking for huge gains but want to earn more than, say, a standard savings account or money market account often choose this sort of fund vehicle. Most countries including the United States regulate the mutual fund market and have a number of restrictions and rules when it comes to investment practicalities. These sorts of funds, like most investments, do carry some risks, so anyone thinking of putting money into them is usually wise to do some individualized research and make an informed decision. Most brokers and investment agents also make themselves available for consults with potential investors, often at no cost.

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Basic Concept

In most cases, the funds work like miniature loans between an institution that has issued a mutual fund, often to pay down debt, and an investor. These accounts are sometimes also called principal stability funds or money market mutual funds. In most places they are required by law to invest in highly liquid, low-risk securities, thereby decreasing the risk of loss due to credit fluctuations, market shifts, and liquidity. The first money market fund, The Reserve Fund, was established in 1971 by American financier Bruce R. Bent, and offered investors a way to preserve their cash while earning a small rate of return. The market has evolved a lot since then, but the core essentials of this sort of account have remained more or less stable.

Management Essentials

The funds are professionally managed, collective investment schemes that pool money from a number of investors and typically invest in government securities, certificates of deposit, or asset-backed commercial paper. Though money market funds usually have a very low risk, they also have lower rates of return. Unlike most other collective investments, money market shares are liquid, and redeemable at any time.

Applicable Regulations

Many if not most national governments regulate this sort of investment, at least on a broad level. In the United States, the Investment Company Act of 1940 is used by the Securities and Exchange Commission (SEC) to regulate all money market accounts and funds. Funds typically buy the debt with the highest rating that matures in less than 13 months. Under law, aside from government-backed securities and repurchase agreements, the portfolio cannot invest more than 5% in any one issuer.

The Weighted Maturity Average (WAM), which is the combination of the amount of time remaining in each loan multiplied by the percent of the overall loan pool each loan has, is also considered in most regulatory schemes. Money markets must have a WAM of 90 days or less. Rule 2a-7 governs these limitations.

Getting the Money Out

Different funds have different policies, but in most cases investors can withdraw some or all of the held assets at practically any time. Some accounts have minimum investment balances that need to be considered, but not all do.

Redemption of money market shares are usually paid out within seven days of tender. In the United States, Section 22(e) of the Investment Company Act of 1940 states that registered open-ended companies cannot suspend the right of redemption of money market shares. It also says companies must pay proceeds of redemption within seven days, unless certain cases or emergencies are permitted by the Commission.

Understanding the Risks and Rewards

This sort of market fund aims to keep its net asset value (NAV) at $1.00 US Dollar (USD) per share, with only the yield fluctuating. Though losing on a money market fund is rare, it is possible. The Reserve Fund shares fell to $0.97 USD on Tuesday, 16 September 2008, in what is called "breaking the buck." This happened after debt issued by Lehman Brothers, who filed for bankruptcy a day earlier, was written off. This failing caused huge investor anxiety the world over.

Money market and other mutual funds traditionally have not been insured by the federal government, unlike money market deposit accounts. In response to the events of September 2008, however, the US Treasury Department announced a temporary guarantee program for US market funds. Before investing in a money market fund, it is important that the potential investor read all of the fund’s available information. This would include the prospectus, its profile, its most recent shareholder report, and anything else available. Speaking with a professional investment manager can also be a good idea.

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