Money market funds (MMF’s) are one of the most common forms of cash management products. MMF’s seek to maintain a stable net asset value of $1 per share through investment in short-term, high quality investments. By investing in these type of instruments, MMF’s limit their exposure to interest rate and credit risk. MMF’s are registered with and regulated by the Securities and Exchange Commission’s (SEC) under SEC Rule 2a-7 of the Investment Company Act of 1940. Rule 2a-7 sets strict requirements regarding the credit quality and maturity of investments and diversification of the investment portfolio. MMF’s are typically safe and liquid, but as a result, they don’t pay high returns like other riskier investments can.

MMF’s provide a suitable vehicle for investing short term cash. MMF’s have substantially less risk compared to stocks and longer term bond funds. The stability of the share value means that if you invest a dollar, you will be able to withdraw a dollar. Additionally, MMF’s are highly liquid meaning investors can buy into and sell out of the funds with relative ease.

Even though money market funds are typically safe there are some risks to investing in MMF’s. First, there is no guarantee that the share price will stay at $1 per share. Money market funds are not FDIC insured and therefore investments in the funds are not guaranteed. Stress in the investment markets, such as those experienced during the 2008 financial crisis, could result in the market value of the fund falling below a $1 per share. If the share price drops, an investor could potentially be exposed to losses in the value of the investment. 

A second risk has to do with inflation. Because MMF’s are considered to be safer than other investments such as stocks, the long term average return on money market funds tend to be less than the long term average return on riskier investments. So over long periods of time, inflation can eat away at what you earn. For example, if over a period the average return on an MMF is 0.5% and inflation averages 2.0%, then the investors real return is -1.5%. The negative return reflects the decreased purchasing power of funds invested over that time.