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Why Invest in a Money Market Fund?
by Christopher Hundley
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Overview
When allocating assets in your retirement account or taxable brokerage account, you have quite a few options including, but not limited to: stocks, bonds, mutual funds, ETFs, REITs, options and money market funds. A cursory review of each asset class reveals that over long periods of time, money market mutual fund returns will be outpaced by practically all other speculative investments. So why invest in a money market fund?
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Definition
Money market funds are mutual funds of which the assets are invested in relatively low-risk investments, such as treasury securities, commercial paper, repurchase agreements and short-term bonds.
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Money Market Fund Returns
Investing in a money market fund allows you to take advantage of fluctuations in the short-term debt market. Money market funds, particularly high-performing money market funds can, but are not guaranteed to, outpace inflation. A money market fund may help ensure that inflation does not erode the purchasing power of your savings, especially if you are using your money market fund to save for short-term goals. Money market funds generally also provide higher returns than bank money mark accounts, even if they are not FDIC-insured.
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Investment Funding
Investing in a money market fund, or similarly highly liquid investment, allows you to take advantage of fluctuations in other markets. For example, suppose a fundamentally sound stock's price is suddenly depressed by unsubstantiated rumors, excessive speculation or other short-term forces. If you have a portion of your money in a liquid account like a money market fund, you can buy (more) shares of that stock to take advantage of the temporarily depressed price. By contrast, if all of your portfolio's holdings are tied up in stocks, bonds, and other securities, you may be forced to sell those holdings to take advantage of the aforementioned opportunity, even if it is not advantageous from a speculative and/or tax standpoint to do so.
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Hedge Against Speculative Losses
While money market fund returns do not typically outpace those of many other investments, such as stocks, bonds or real estate, in the case of a catastrophic market event, such as that which occurred September 2008, money market funds can produce a useful hedge against loss.
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Considerations
Carefully review the prospectus of any money market fund in which you are considering investing your savings. There may be annual fees that can erode your returns.
Unless your money market fund is housed within a tax-deferred account, such as a Traditional 401k or 403b plan, you will have to pay taxes on the returns. This may not be an issue for you if your primary objective is liquidity and stability over the short term, but if you are investing in a money market fund for the income as well, you may be better off investing in another asset, such as a tax-free municipal bond fund. However, consult your financial adviser before making a decision.
