Money Market Funds
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Money market funds are basically a special form of mutual funds.
That is, the money of all shareholders is pooled to buy a large inventory of securities. Most people think of mutual funds as stocks, and that's true of many of them. Some are bonds. However, money market funds are comprised of a large number of short term loans where corporations and state and local governments borrowed money.
Money Market Funds are Low Risk Parking Places for Cash
Because these loans are very short-term (money fund companies are required by the SEC to keep their average maturity dates under 60 days, and in practice they're usually only around 40 or 50 days), they are very low risk and therefore also pay very low rates of interest.
In general, they a money market account pays a higher rate of interest than a bank's passbook savings account, but slightly under the interest paid by certificates of deposit.
One reason for that is that money in money market accounts is liquid. You can access it at any time, with a check or a debit card.
However, they do require the check be higher than a certain amount (such as $100 or $250) and may charge you a fee if your balance goes below a set amount, such as $2,000 or $3,000. Also, there is usually a limit to how many checks you can write or withdrawals you can request within any one month.
Nevertheless, they are a lot less hassle for getting hold of your money quickly than are CDs, which make you go through a lot of paperwork and yell at you about how you have to pay a penalty.
The interest rates paid by money funds nowadays probably will not keep up with inflation in the long run, so the only money you should keep in these kinds of accounts for the long term is an emergency fund that ensures that if you're laid off or suffer some other catastrophe, that you can pay your bills for at least three to six months.
Money Market Funds are Good for Storing Cash Outside the Stock Market
Otherwise, money funds should be used only for short term money. However, short term can be five to ten years, because your alternative is to invest in the stock market, but that is volatile, and you should not buy stocks you don't plan to hold for at least ten years -- preferably twenty.
Therefore, you should use it for money to pay for a college education (if the child is out of elementary school), a house or car downpayment, a wedding, a vacation, or to pay off a car or house loan before you've saved enough to pay the entire principal amount (on these kinds of loans, never pay anything extra until you can pay 100% of what you owe.)
It's smart money management to have your paycheck go direct deposit into your money market fund account. Then it can draw interest until you need it. At which time you write a check on that fund and deposit it into your ordinary bank checking account, so you can pay your small bills. For big bills such as your car and house notes, you can write checks directly on the market market account.
That may not seem like a big thing, and with today's interest rates it's not going to make you rich. But the point is that it's still forcing your money to work for you.
Look for money market mutual fund families that charge low management expense fees. 0.6% is a normal money fund expense ratio, so look for something lower than that, such as Vanguard's Prime Money Market with an expense ratio that's 0.27% instead.
Remember, management fees come out of your pocket. Some are necessary, but it's smart to minimize them.
Money market funds can't make you rich, but they're an important personal financial tool.
Next: Money Market Investment -- how a money market accounts fits into your personal finances.
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