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This tutorial covers mutual funds that invest in the money market. The money market is the market for short-term debt securities. Short-term debt securities are loans governments and corporations sell to investors. They mature between one day and one year, depending on the type, and pay competitive returns.
This tutorial will introduce these funds and will explain some of their characteristics. We will discuss the following:
WHAT IS A MONEY MARKET MUTUAL FUND?
Money market mutual funds invest in short term debt obligations of corporations and governments. They bring these investments to the small investor. For a small initial investment as low as $500 (depending on the fund), you can participate in money market investments. Money market instruments provide high-yields on short-term investments. Direct participation in the money market would require investments of $10,000 or more. The funds pool money from large numbers of investors and use it to buy these securities.
The net asset value (the value of a single share, determined daily) of a money market fund is kept at $1. Although not guaranteed to stay at $1, money market fund NAVs have usually been kept at $1 due to the stability of the underlying investments. This means that if you own 3,380 shares, your fund will be worth $3,380. Fund managers have been able to maintain the $1 per share value by allowing the dividend rate to fluctuate rather than the share price.
The returns on money market funds depend on the yields of their individual holdings and will fluctuate due to the short term of money market instruments. This causes the overall yield of a money fund to fluctuate as well. Investors who hold money funds can track the funds' yield changes in the financial pages of most major newspapers.
IN WHAT DO MONEY MARKET FUNDS INVEST?
Money market funds invest in Treasury bills, commercial paper, banker's acceptances, negotiable certificates of deposit, repurchase agreements and short-term debts of U.S. Government agencies. A fund's prospectus or quarterly report will list the instruments it uses. Money market funds come in a variety of forms, described below.
Tax-exempt money funds invest in municipal securities with very short maturities (30-90 days). The interest they earn is free from federal tax and some state taxes. Because of the tax-free feature, however, their yields are comparatively lower than those of taxable funds. Over 300 tax-exempt money funds are available on the market.
U.S. Treasury funds buy short-term U.S. Treasury bills (T-bills). Their yields are also comparatively lower than those of other funds because their income is free from state and local taxes. These funds are considered very safe.
U.S. Government funds buy T-bills, federal agency notes and repurchase agreements.
Money market mutual funds invest in a large pool of holdings made up of any of the investments listed above, concentrating on non-government securities.
You can learn more about each of these investments by consulting the individual tutorials on the money market, municipal bonds and government bonds.
SAFETY CONCERNS ABOUT MONEY MARKET FUNDS
The Federal Deposit Insurance Corporation (FDIC) insures bank deposits up to $100,000, but does not cover money market mutual funds. This is a concern to some investors. You can, however, get a money market deposit account from a federally insured bank. This is a savings account that pays money market rates (usually higher than a passbook account). Initial deposits for these accounts start at $5,000 or $10,000.
Money market funds are considered very safe because of their low volatility and creditworthiness of the issuers. Money market mutual funds tend to have low overhead costs. These savings are ultimately passed on to investors in the form of yields that are higher than what money market deposit accounts, CD's and savings accounts pay.
A second concern with these funds is inflation risk. Real returns are affected or even overcome by inflation. Because returns in a money fund fluctuate greatly, inflation can chip away at returns that happen to be low in a given year.
Money market funds do not just sit idle. Learn about the things you can do with them below.
WAYS YOU CAN USE MONEY MARKET FUNDS
Money market funds come with some privileges that most other mutual funds do not have.
You can write checks from your money market fund without charge. Most funds, however, will require that checks be written for a minimum amount of $250 or more.
You can use a money market fund for business purposes. You can deposit checks from customers and pay bills out of your account.
A fund can be used as a temporary place to park money that is awaiting investment in another security. Some investors place large sums into these accounts and then withdraw them gradually for placement into stocks and bonds. Many investors also keep cash in their money market funds for emergency use.
Some funds, for a fee, will allow you to withdraw cash from ATMs.
Once you have established a money market fund, you can invest in other funds within the same family without filling out an application.
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