What are the Advantages of Money Market Funds

Before money market funds became available to the general public in the early 1970s, if you wanted to keep your money somewhere that was safe and liquid (as US savings bonds were not), but yet earned some interest (as checking accounts did not), you had one choice. One choice only -- passbook savings accounts.

The amount of interest banks and savings and loans paid their savings account holders was highly regulated, and puny compared to interest rates available to holders of commercial paper, Treasury bills and so on.

The first advantage to money market accounts is that they make available to individual investors the types of yields that previously were available only to financial institutions and wealthy investors.

Unlike other types of mutual funds, they retain a net asset value of $1

They are highly regulated by the Security and Exchange Commission (SEC), and required to invest only in the most highly rated forms of short-term, fixed-income investments.

They closely track prevailing short-term interest rates. If short-term interest rates in the general economy go up, so do the yields on your money fund.

You have the option of investing in general purpose funds that are free to invest in all safe, short-term fixed-income securities for the highest possible yield, or investing in the highly safe Treasury bills and U.S. government agency securities, or in tax-exempt funds.

They're available from a wide range of financial institutions: mutual fund families, brokerages, banks -- even Pay Pal

A money market account is quite liquid. You can access your money by writing checks, making a withdrawal by telephone, by the Internet, by debit cards (in some cases) or by having automatic withdrawals sent to your local checking account at specified periods and amounts.

They earn daily dividends on your money. (It's actually paid monthly.)

The return is higher than banks pay on their savings accounts or short-term certificates of deposits. They pay the highest dividends available on money that is both safe and liquid.

Because the NAV is always $1, there are tax consequences involved from withdrawing your money, because there are no capital gains or losses. (Dividends paid are taxable income.)

You can have your paycheck go direct deposit into them the same as it can into your local account. Just provide your human resources department with the routing number and account number. This is a smart way to earn dividends on money you're not using, or until a check you wrote clears.

The principal is very safe -- no individual investor has yet lost a penny of their principal.

This makes money market savings accounts the perfect place to park cash that you'll need in the near-term future:

Money you'll soon need for living expenses

Money you haven't decided where yet to invest

Money you're saving for a downpayment on a house

Money you're saving for a child's college education

Money you're saving for a vacation

The stock market is far too volatile to keep short-term money in. You may think you've finished saving up the $20,000 you need to put down on your first house . . . only to find out the day after you sign the contract that the stock market crashed and now you have only $15,000!

Bonds are not as volatile, but you can still lose principal. If interest rates go up, you could learn that the money in your bond fund is now not enough to pay for your child's college tuition.

These funds give you a broad diversification

Any security is only as good as the entity that issues it. If the entity is in financial trouble and may not be able to pay their obligations, its securities are at risk. This can and, in a very few instances, has happened with money market accounts. However, individual investors didn't notice because the loss of one security did not make them lose any money. But if they'd held the defaulted security directly, they would have lost most or all of their money.

Also, if you invested in commercial paper directly, you should have to go through a dealer who would charge you a relatively high fee. However, money market managers have millions of dollars to invest when they go shopping for short-term debts. This means they have the leverage to demand a "wholesale" price, which saves you money.

I've seen financial books suggest putting short-term money into short-term bond funds instead of money market funds. If interest rates go up, the short-term bond fund will yield slightly more.

However, there is a risk of loss of principal. If interest rates go up, your money market deposit account will be worth less money. Therefore, for keeping your short-term money safe, money market funds are the better choice, because they retain their $1 per share net asset value.

For keeping short-term money safe and earning yet more money, money market funds can't be beat. However, you should also learn the disadvantages of money market funds

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