Money Market Fund

A money market fund is a mutual fund that invests exclusively in short-term, highly liquid, low-risk securities — US Treasury bills, commercial paper (short-term corporate debt), certificates of deposit, and repurchase agreements. Money market funds aim to preserve capital and earn a modest yield while maintaining liquidity. They are the closest thing to a “cash” investment that offers interest income.

What money market funds hold

A money market fund’s portfolio is highly constrained by regulation and tradition:

Treasury bills (T-bills). Short-term US government debt (3, 6, or 12 months). Zero default risk, extremely liquid.

Commercial paper. Short-term debt issued by corporations (typically maturing in 1–270 days). Slightly higher yields than T-bills because corporations are riskier than the government.

Certificates of deposit (CDs). Short-term deposits at banks, often maturing within 90 days.

Repurchase agreements (repos). The fund lends money to a securities dealer and receives securities as collateral, with an agreement to buy back the securities at a set price. Repos are the oil that lubricates short-term finance.

Other money market instruments. Bankers’ acceptances, federal funds (overnight loans between banks), and other short-term instruments.

The fund is prohibited from holding securities with maturity longer than 397 days (SEC rule), ensuring that the portfolio remains genuinely short-term and liquid.

Why money market funds exist

Money market funds serve several purposes:

Cash management. Investors between trades or in transition can park cash in a money market fund, earning a modest yield while maintaining instant access.

Employer retirement plans. 401(k)s and 403(b)s offer money market funds as a conservative investment option for employees who are not comfortable with stocks.

Emergency funds. Though less popular now, money market funds were once the standard for emergency reserves.

Treasury alternative. For large investors, money market funds can offer slightly higher yields than direct Treasury bill ownership, with easier access.

Money market fund types

The SEC recognizes three types:

Prime money market funds. Hold commercial paper and other corporate debt. Higher yields but slightly more credit risk than Treasury-only funds.

Government money market funds. Hold Treasury bills and other US government debt. Lower yields but minimal credit risk.

Tax-exempt money market funds. Hold municipal (state and local) bonds. Yields are lower but interest is federal-tax-exempt (sometimes state-tax-exempt too).

The money market fund crisis of 2008

Money market funds are normally rock-solid, but a significant vulnerability emerged in 2008. During the financial crisis, the Reserve Primary Fund (the largest prime money market fund) had invested heavily in Lehman Brothers commercial paper. When Lehman collapsed, the fund’s net asset value fell below $1 per share—a “breaking the buck” event that had been thought impossible.

This triggered a panic. Investors withdrew from prime money market funds en masse, forcing the funds to sell illiquid commercial paper at distressed prices. The US government had to guarantee money market funds and provide emergency lending to restore confidence.

Since then, money market funds have been subject to stricter regulations:

• Liquidity requirements. Funds must hold a minimum percentage of extremely liquid holdings (cash, T-bills).
• Capital buffers. Funds must maintain a small reserve against losses.
• Redemption restrictions. During stress, funds can impose a small redemption fee (0.5%) or a brief gate (halt redemptions for up to 10 days).

These changes reduced yield slightly but significantly improved stability.

Yields and interest rate sensitivity

Money market fund yields are directly tied to interest rates. When the Federal Reserve raises rates, newly maturing securities and new purchases are rolled into higher-yielding instruments, and money market fund yields rise.

In the low-interest-rate period of 2010–2021, money market fund yields were near zero. Investors were sometimes paying expense ratios to lose money in real (inflation-adjusted) terms. Since 2022, when the Fed has raised rates dramatically, money market funds have become more attractive, offering 4–5% yields.

Is a money market fund right for you

Money market funds are suitable for:

• Cash reserves. A few months of emergency expenses, accessible instantly and earning some return.
• Transition accounts. Money between stock and bond purchases.
• Conservative investors. Those with no appetite for equity risk.
• Large sums awaiting deployment. Waiting for stock market opportunities while earning current interest rates.

They are not suitable for:

• Long-term investing. The returns barely outpace inflation over time.
• Growth. Money market funds will never build wealth.

For most of the past decade, holding cash in a money market fund meant losing to inflation and bonds offered better risk-adjusted returns. The recent interest rate environment has improved money market fund attractiveness, but the long-term dynamic remains: bonds usually beat money market funds.

See also