A money market fund is a type of mutual fund that holds short-term debt instruments—mostly government bonds, corporate IOUs due within a year, and bank certificates of deposit.
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 aims to keep its share price stable at $1.00 per share, though that is not may provide. You earn interest through the fund's yield, which changes as the underlying securities mature and are replaced.
Money market funds are different from money market accounts in a practical way: a fund is an investment product you buy through a brokerage or directly from a fund company, while an account is a bank deposit product. Both sit at the safer end of the investment spectrum, but they work through different institutions and carry different protections.
Key Takeaways
- Money market funds hold short-term debt like Treasury bills and commercial paper, not cash deposits.
- Your money is not FDIC-insured in a fund the way it is in a bank money market account.
- The fund's yield fluctuates based on interest rates and the securities it holds, so your earnings change over time.
- You can usually withdraw your money within one to three business days, making funds more liquid than bonds but less liquid than a checking account.
How money market funds earn you interest
A money market fund earns interest by holding securities that pay interest. When you buy a share of the fund, you own a piece of that portfolio. As the securities inside pay interest or mature, the fund distributes those earnings to shareholders as dividends. The fund's yield—the annual return you see quoted—reflects what the current holdings are expected to pay.
The yield changes frequently because the fund is constantly selling securities that mature and buying new ones. When interest rates rise, new securities pay more, so the fund's yield goes up. When rates fall, the opposite happens. This is why a money market fund's return is never locked in the way a certificate of deposit's return is.
Most money market funds reinvest dividends automatically, meaning the earnings are used to buy more shares of the fund rather than paid out as cash. You can usually change this setting if you want the dividends sent to you instead.
The difference between government, prime, and tax-exempt money market funds
Money market funds come in three main types, depending on what securities they hold. A government money market fund invests primarily in U.S. Treasury bills and other federal debt. These are the safest option because they are backed by the U.S. government, though they typically pay lower yields than other types.
A prime money market fund holds corporate debt and other short-term IOUs from companies and banks. These pay higher yields than government funds because the issuers are riskier than the federal government. During financial stress, prime funds can face losses if issuers default, though this is rare.
A tax-exempt money market fund holds municipal bonds—debt issued by states, cities, and local agencies. The interest you earn is usually not subject to federal income tax, and sometimes not state income tax either if you live in the issuing state. These funds make sense only if you are in a high tax bracket and the after-tax yield is better than a taxable fund.
Risks and limits you should know
Money market funds are not risk-free, even though they feel safe. The fund's share price can fall below $1.00 if the securities inside lose value or if issuers default. This happened to some prime funds during the 2008 financial crisis. The fund company may step in to prevent losses, but they are not required to do so.
You also face interest rate risk. If you lock money into a fund and rates rise sharply, you are earning less than you could earn elsewhere. Unlike a CD, you can move your money, but you may have to wait a few business days for the transfer to settle.
Some funds impose limits on how much you can withdraw or how often you can withdraw during periods of market stress. These gates are rare but possible. Check the fund's prospectus to see what restrictions apply.
How to open a money market fund
You open a money market fund through a brokerage firm, a mutual fund company, or sometimes through your bank. Common fund providers include Vanguard, Fidelity, Schwab, and iShares. You will need to open an account with the provider, link a bank account for deposits and withdrawals, and choose which fund to buy.
Most funds have a minimum initial investment, which ranges from $1,000 to $3,000 at many providers, though some have no minimum. You can usually buy additional shares anytime. The fund will send you a prospectus—a legal document that describes the fund's holdings, fees, and risks—before or when you invest. Read the fee section carefully; expense ratios typically range from 0.2% to 0.5% per year, though some are lower.
Once you own shares, you can check your balance and earnings online. Dividends are usually paid monthly or daily, depending on the fund. You can withdraw your money by selling your shares, which typically settles in one to three business days.
Money market funds versus money market accounts
A money market account is a bank deposit, so it is FDIC-insured up to $250,000. A money market fund is an investment, so it is not insured. If the fund company fails, you have some protection through the Securities Investor Protection Corporation (SIPC), but that is not the same as FDIC insurance.
Money market accounts usually have lower yields than money market funds because banks are conservative with the money they hold. Money market funds can chase higher returns because they are actively managed and can hold riskier short-term debt. However, that higher yield comes with the trade-off of no FDIC protection.
Money market accounts may also have monthly withdrawal limits or require you to maintain a minimum balance. Money market funds typically have no balance minimums after the initial investment and no withdrawal limits, though some funds may restrict access during market stress.
When a money market fund makes sense for your money
A money market fund works well if you have money you do not need immediately but want to keep accessible and earning more than a savings account. They are useful as a temporary holding place while you decide where to invest longer-term, or as a way to park an emergency fund that earns a decent return.
If you are in a high tax bracket and live in a state with high income tax, a tax-exempt money market fund may reduce your tax bill. If you want the absolute safest option with FDIC insurance, a money market account at a bank is the better choice, even if the yield is lower.
If you need the money within days or want a may provide return, a money market fund is less suitable. A high-yield savings account or a short-term CD may serve you better.
Frequently Asked Questions
Can I lose money in a money market fund?
Yes, though it is uncommon. If the securities inside the fund default or lose value, the share price can fall below $1.00. Most money market funds are designed to keep the share price stable, and fund companies sometimes step in to prevent losses, but they are not required to do so.
How often can I withdraw money from a money market fund?
Usually as often as you want, with the money settling in one to three business days. Some funds may restrict withdrawals during periods of market stress, so check your fund's prospectus for any gates or limits.
What is the difference between a money market fund's yield and its expense ratio?
The yield is what the fund earns from the securities it holds. The expense ratio is what the fund company charges you to manage it, usually 0.2% to 0.5% per year. Your actual return is the yield minus the expense ratio and any taxes you owe.
Is a money market fund better than a savings account?
A money market fund typically pays more interest than a savings account, but it is not FDIC-insured and the share price can fluctuate. A savings account is safer but earns less. The choice depends on whether you prioritize safety or yield.
Can I use a money market fund as an emergency fund?
Yes, if you can wait one to three business days to access the money. If you need cash within hours, a checking or savings account is better. A money market fund works as a secondary emergency fund or a place to park money you do not need immediately.