Advantages and Disadvantages of Money Market Funds

While they are not the absolute safest investment product on the market, money market funds are seen to be a relatively safe, albeit short term, investment product for those who don’t want to keep their money tied up indefinitely. Even so, there are some advantages and disadvantages of money market funds that should be considered before investing in them.

Disadvantage: Confusion between Money Market Funds and Money Market Accounts
Perhaps the greatest disadvantage of money market funds is in the fact that many people get them confused with money market accounts. A money market fund is a type of mutual fund in which the fund is managed by a fund manager and various bonds and financial products are purchased and held in the fund. Investors make money when those financial products make money. A money market account is, for all intents and purposes, a bank account that simply earns a higher annual yield than a regular account since the customer’s money stays there longer for the bank or financial institution to use in their own investments.

Disadvantage: Not Insured by the FDIC
This leads to what is perhaps the greatest disadvantage of money market funds. Unfortunately, they are not insured by the FDIC. Although it is rare to lose a significant amount of money in money market funds since they are regulated by the SEC, it still happens from time to time. Many people mistakenly think that their money is insured because they get money market funds confused with money market accounts which are backed by the federal government up to $250,000.

Disadvantage: Problems Inherent in Short Term Investments
Another problem that many people find works to their disadvantage is in the fact that money market funds are short term financial products that, according to government regulation, are no longer than 397 days. While the investments within the funds usually mature within 90 days and new products are added all the time, the fund itself cannot last longer than the legislated (by the SEC) timeframe of 397 days. By the time many of these funds are taxed the yield is lower than they would have liked as they didn’t have sufficient time to realize significant gains.

Advantage: Diversified Portfolio
On the other hand, the fact that each of the underlying assets mature in 90 days there is a constant influx of new financial instruments in the fund. This leads to greater diversity along with the fact that the SEC has regulated that no more than 5% of the fund can be in any one type of investment product (accept of course government bonds). The greater diversity of money market funds reduces a great deal of risk and provides greater potential for gain.

Advantage: Liquidity & Yield
One of the advantages of money market funds is in terms of reinvesting the yield as underlying short term assets are sold. For example, a bond is at the 90 day maturity date so it needs to be liquidated (sold) according to regulations. Now, not only is another investment made for the fund, but the yield from that liquefied asset is also placed back into the fund which leads to greater profit.

Advantage: Relative Safety
Although money market funds are not insured by the FDIC they are closely regulated by the SEC which means that there is a certain margin of safety. Since one of the most important aspects of a money market fund is the diversity of the underlying assets, there is some protection against a significant amount of loss because each financial instrument is within a different sector of the market. (And those that are government backed bonds are guaranteed.)

Anyone looking for a relatively safe, short term investment would do well to consider the advantages and disadvantages of money market funds. While it isn’t probable to get rich quick with money market funds, it is a good investment for someone looking for a place to invest some money for a short period of time so that they can cash in as needed a few steps down the road.

Comments are closed.