A money market fund is a type of mutual fund that holds short-term debt—mostly government bonds, corporate IOUs due within a year, and cash equivalents—and pays you interest on your balance.
Unlike a money market account at a bank, a money market fund is not insured by the FDIC. It is managed by an investment company that pools your money with other investors' money and buys these short-term securities. The fund's value stays close to $1 per share, but it can move slightly. You earn interest based on what the fund holds and how much those holdings pay.
The main reason people use money market funds is that they typically pay more interest than a regular savings account or money market account, especially when interest rates are higher. The trade-off is that your money is not may provide by federal insurance, and the fund's value can fluctuate—though rarely by much.
Key Takeaways
- A money market fund invests in short-term debt securities like Treasury bills and commercial paper, not in stocks or long-term bonds.
- Your money is not FDIC-insured in a money market fund the way it is in a bank money market account, so there is a small risk of loss.
- Money market funds usually pay higher interest than savings accounts, but the rate changes as market conditions change.
- You can buy money market funds through a brokerage account, and many employers offer them in retirement plans like 401(k)s.
How a money market fund pays you
The fund buys short-term debt and collects the interest those securities pay. That interest is passed to you as a dividend, usually paid monthly or quarterly. The fund also charges a small fee—called an expense ratio—which comes out of your returns. A typical expense ratio ranges from 0.1% to 0.5% per year, though some funds charge less.
The interest rate you earn is not fixed. It moves with the market. When the Federal Reserve raises interest rates, new securities the fund buys pay more, so your dividend goes up. When rates fall, your dividend falls. This is different from a bank money market account, where the rate can change but is set by the bank and may not move as quickly.
The difference between a money market fund and a money market account
A money market account is a bank product. Your money is insured up to $250,000 by the FDIC. The bank pays you interest, and you can usually write checks or use a debit card. The interest rate is set by the bank and can change, but the bank decides when.
A money market fund is an investment product. Your money is not FDIC-insured. You own shares of a mutual fund that invests in short-term debt. The interest you earn depends on what those securities pay. You typically cannot write checks directly from the fund, though you can sell shares and move the money to your bank account, which usually takes one to three business days.
In a low-interest-rate environment, the difference in returns may be small. When rates are higher, money market funds often pay noticeably more than bank money market accounts. Check the current rates at both your bank and a brokerage to compare.
Where to buy a money market fund
You can buy money market funds through a brokerage account at firms like Fidelity, Vanguard, Charles Schwab, or your bank's investment division. You open an account, deposit money, and choose a money market fund from the options available. The process usually takes a few minutes online.
Many employers also offer money market funds as an investment choice in 401(k) retirement plans. If your plan includes one, you can direct a portion of your contributions into it. This is useful if you want a very stable, low-risk holding within your retirement savings.
The risk in a money market fund
Money market funds are considered very low-risk because they hold short-term, high-quality debt. However, they are not risk-free. The fund's share price can drop if the securities it holds lose value or if the fund experiences large withdrawals. In rare cases, a money market fund has "broken the buck," meaning its share price fell below $1. This happened to a small number of funds during the 2008 financial crisis, but it is uncommon.
The bigger practical risk is that your returns will be low. If inflation is rising faster than the interest the fund pays, you are losing purchasing power. Money market funds are best for money you need to keep safe and accessible, not for long-term growth.
When a money market fund makes sense
Use a money market fund if you have cash you want to hold short-term—anywhere from a few months to a couple of years—and you want a return higher than a savings account. It is also useful as a "parking place" in a brokerage account while you decide where else to invest, or as a stable holding in a retirement plan.
Do not use a money market fund as a substitute for an emergency fund if your bank offers FDIC-insured savings. The slight extra interest is not worth the lack of insurance protection. Do not use it for money you need within days, because selling shares and moving the money to your bank account takes time.
Frequently Asked Questions
Can I lose money in a money market fund?
Yes, though it is rare. The share price can drop if the securities the fund holds decline in value or if many investors withdraw at once. The fund is not insured by the FDIC. However, money market funds hold very short-term, high-quality debt, so losses are uncommon and usually small.
How quickly can I get my money out of a money market fund?
You can sell your shares in one to three business days, depending on the brokerage. The money then moves to your brokerage account, and you can transfer it to your bank. If you need cash within hours, a money market fund is not the right tool—use a bank savings account instead.
Do I pay taxes on money market fund interest?
Yes. The dividends you receive are taxable income in the year you receive them. If the fund holds municipal bonds (issued by states or cities), some of that interest may be tax-free, depending on where you live and which bonds the fund owns. Ask your brokerage or the fund company about the tax treatment of your specific fund.
Is a money market fund the same as a money market account?
No. A money market account is a bank product with FDIC insurance. A money market fund is an investment product with no insurance. Money market accounts are safer but usually pay less interest. Money market funds pay more but carry a small risk of loss.