What Is A Money Market Fund?
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Investing can take many forms, and money market funds offer just one of the plethora of investment vehicles Canadians can park their capital in. Money market funds are best suited for those looking for a low-risk, short-term investment that offers liquidity.
Let’s dig deeper into money market funds to help you determine if this is the right avenue to take to invest your money.
What Is A Money Market Fund?
A money market fund is a type of mutual fund that invests in liquid and short-term securities. As such, they’re more common among investors who are looking for more flexibility with their cash management and a short-term investment to add to their investment portfolio.
Like mutual funds, money market funds involve a portfolio of securities with shares that are sold to investors.
Money market funds are conservative investment funds that are best suited for those with a low tolerance to risk. Any income generated is typically associated with short-term interest rates, so they’re not ideal for long-term investment strategies.
When investors buy shares in a money market fund, the capital is used to purchase short-term securities, including the following, all of which are short-term:
- Bankers’ Acceptances. Bank-backed debt that promises a future payment.
- Certificates of deposit. Savings certificates issued by banks.
- Commercial paper. Unsecured corporate debt.
- Repurchase agreements. Government securities.
- Treasuries. Government debt obligations.
Money market funds try to hold a net asset value (NAV) of $1 per share, and the difference between the NAV price and portfolio earnings are paid out to investors in the form of dividends. This ensures that investors are paid on a regular basis, though the amount paid out is not necessarily the same every payout.
Depending on the type of money market fund portfolio, any income earned may be taxable or tax-exempt.
Types Of Money Market Funds
There are a few main types of money market funds, including the following:
- Prime. Invests in commercial paper and corporate notes of non-Treasuries, such as certificates of deposit, US-government debt, and government-sponsored enterprises (GSEs).
- Government. Invests the majority of its total assets in cash, repurchase agreements, and government securities that are entirely collateralized by cash or government securities.
- Tax-exempt. Composed of municipal securities exempt from federal income tax. Municipal bonds and other types of debt securities predominantly make up these types of money market funds.
All of these money market funds must adhere to regulatory requirements in terms of the fund’s investment diversification, the investment types held, their liquidity, and their maturity.
Check out our list of Popular Canadian Index Funds.
Money Market Fund Vs Money Market Account
Some may confuse money market funds with money market accounts, but they are not the same. Whereas a money market fund is regulated by the Securities and Exchange Commission (SEC) in which your capital is invested in the stock market, money market accounts are a type of savings account that is insured by the Federal Deposit Insurance Corporation (FDIC) and offered by banks and other financial institutions.
Essentially, a money market fund is an investment instrument, while a money market account is more or less of a general savings account. Since money market accounts involve investing money, there is a risk that comes with losing capital.
However, they are a low-risk type of investment, so they are a much safer way to invest compared to other investment vehicles. Because of their investment component, money market funds offer a greater opportunity to earn higher returns compared to money market accounts.
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Pros And Cons Of Money Market Funds
There are several perks that come with investing in money market funds to earn returns over the short term. However, there are also some drawbacks to consider.
- Low risk. The diversification and low volatility of money market funds make them a relatively low-risk investment.
- Low investment requirement. Unlike other types of investments — like real estate — money market fund investing does not require a massive upfront investment of capital.
- Better returns than a savings account. Both money market funds and high-interest savings accounts are safe ways to invest your money, but the former offers a much higher potential for returns.
- Expense ratio. Money market funds charge a fee to cover the cost of managing the fund, which is known as the “expense ratio.” This fee can eat into your earnings made from the fund and leave you with less.
- Inflation. Since money market funds are low-risk investments, they offer lower returns than riskier investments like stocks. As such, inflation can reduce your returns over time.
- No guarantee on return. While there is very little risk associated with investing in a money market fund, there is also no guarantee on the rate of return.
Should You Get A Money Market Fund?
Money market funds are ideal for certain types of investors. If you’re a conservative investor who’s looking for a low-risk investment that offers high liquidity, then a money market fund may be worth looking further into.
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