The Pros and Cons of Money Market Funds (2024)

What Are Money Market Funds?

Money market funds are a type of mutual fund that invests in highly-rated, short-term debt securities. They generate income but little if any capital appreciation. Money market funds were established in the 1970s to provide a slightly higher-yielding alternative to interest-bearing bank accounts.

Money market investing typically carries a low single-digit return. When compared to stocks or corporate debt issues, the risk to principal is generally quite low. However, investors need to weigh several pros and cons when it comes to money market funds.

Key Takeaways

  • Money market investing can be advantageous if you need a relatively safe place to park cash in the short term or if you're diversifying a growth portfolio.
  • Some disadvantages are low returns, a loss of purchasing power, and the lack of FDIC insurance.
  • A money market fund can be ideal in some situations and potentially unwise in others.
  • If you're close to or in retirement and need some of your money soon, a money market fund can make sense.

Advantages of Money Market Funds

Low Risk and Short Duration

When the stock market is extremely volatile, and investors aren't sure where to invest their money, the money market can be a safe haven for it while they decide where to put it to use. Why? As stated above, money market funds are often considered less risky than their stock and bond counterparts.

That's because these types of funds typically invest in low-risk vehicles such as certificates of deposit (CDs), Treasury bills (T-Bills), and short-term commercial paper.

Plus, the short durations of these securities limit a money market fund's sensitivity to interest rate risk.

And even though the money market often generates a low single-digit return for investors, in a volatile or down market, that can be quite attractive.


As with most mutual funds, a money market fund offers instant diversification among a range of securities. Investors don't have to select and invest in various money market securities individually. Diversification is an important safeguard for every portfolio.

Stability and Security

A money market fund is one of the least volatile types of investment available. This characteristic can be useful in offsetting the greater volatility of stock and bond investments you may have in your portfolio. In addition, they give you a secure, short-term investment option when no other is feasible.

A money market account is an interest-paying account opened at a bank. A money market fund is a mutual fund.

High Liquidity

Money market funds generally don't invest in securities that trade minuscule volumes or have little following. Rather, they primarily invest in entities and/or securities in fairly high demand (such as T-bills and short-term T-bonds). This meansthey tend to be very liquid; investors can buyand sell them with comparative ease.

Contrast this to, say, shares of a small-cap Chinesebiotech company. In some cases, those shares may have limited investor interest. This means that getting into and out of such an investment could be difficult if the market were in a tailspin.

Potential Tax Efficiency

Investors in money market funds may find that the interest payments from some fund investments are exempt from federal and, potentially, state income taxes.

Disadvantages of Money Market Funds

Inflation Risk

If an investor is generating a 3% return from their money market fund, but the rate of inflation is humming along at 4%, they are essentially losing purchasing power each year.

Expenses Can Take a Toll

When investors are earning only 2% or 3% from a money market fund, even small annual fees can eat up a substantial chunk of the profit. This may make it even more difficult for money market investors to keep pace with inflation.

Depending on the fund, fees can vary in their negative impact on returns. If, for example, an individual maintains $5,000 in a money market fund that yields 3% annually and is charged $30 in fees, the total return can be impacted quite dramatically.

  • $5,000 x 3% = $150 total yield
  • $150 - $30 in fees = $120 profit

The $30 in fees represents 20% of the total yield, a large deduction that considerably reduces the final profit. The above amount also does not factor in any tax liabilities that may be generated if the transaction occurs outside of a retirement account.

No Federal Insurance Protection

A money market account opened at a bank is typically insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per depositor. However, money market funds are not insured by the FDIC—but the Securities Investor Protection Corporation (SIPC) provides some degree of financial protection for investors.

For instance, if an investor were to maintain a $20,000 money market account with a bank and the bank were to go belly up, the investor would likely be made whole again through this FDIC coverage. On the other hand, if a money market fund were to collapse, the investor could lose some or all of their money because the SIPC only replaces the investments when possible.

The 2008 financial crisis took a lot of the shine off the stellar reputation that money market funds had enjoyed. A large money market fund broke the buck—its shares fell below $1.00—triggering a run on the whole money market industry. Since then, the industry has worked with the Securities and Exchange Commission (SEC) to introduce stress tests and other measures to increase resiliency and repair some of the reputational damage.

Risk of Higher Yields

While money market funds generally invest in government securities and other vehicles that are considered safe relative to investments such as stocks and bonds, fund managers may decide to take some greater risks to obtain higher yields for their investors.

For example,to try to capture another tenth of a percentage point of return, the fundmay invest in bonds or commercial paper that carry additional risk. Depending on your investment objectives and time horizon, investing in the highest-yielding money market fund may not always be the smartest move, given this additional risk.

Remember, the return a fund has posted in a previous year is not necessarily an indication of what it may generate in a future year.

Low Returns Mean Lost Opportunity

Over time, common stocks have returned about 8% to 10% on average (including data from recessionary periods). By investing in a money market fund, which may often yield just 2% or 3% due to the fixed income nature of its investments, an investor may be missing out on an opportunity for a better rate of return. This can have a tremendous impact on an individual's ability to build wealth over time.

What Is In a Money Market Fund?

A money market fund is a type of mutual fund that invests in highly liquid, low risk short-term securities. As such, you'll typically find short-term Treasuries, other government securities, CDs, and commercial paper listed as holdings.

Is a Money Market Account the Same As a Money Market Fund?

No. A money market account is an interest-bearing account that's offered by a financial institution such as a bank (as an alternative to a potentially lower-paying savings account). A money market fund is an investment sponsored by a mutual fund company.

Does the U.S. Government Provide Insurance for Money Market Funds?

No, it doesn't. Nor does it do so for any other type of mutual fund. Money market funds are investments with no guarantee of a return or principal protection. You can lose money with a money market fund investment.

The Bottom Line

As with any other investment, money market funds have pros and cons, which should be considered carefully before buying.

While money market funds aren't ideal for long-term investing due to their low returns and lack of capital appreciation, they offer a stable, secure investment option for individuals looking to invest for the short term.

The comments, opinions, and analyses expressed on Investopedia are for informational purposes online. Read our warranty and liability disclaimerfor more info.

The Pros and Cons of Money Market Funds (2024)


The Pros and Cons of Money Market Funds? ›

Money market funds have benefits such as diversifying your investment portfolio and providing regular income payments. But your money won't be federally insured and you may incur fees.

What are the advantages and disadvantages of money market funds? ›

Money market funds have benefits such as diversifying your investment portfolio and providing regular income payments. But your money won't be federally insured and you may incur fees.

What are the problems with money market funds? ›

There are two main types of liquidity risks faced by money market funds: funding liquidity risk (if the fund's liquidity is insufficient to meet redemptions) and market liquidity risk (if market volatility forces funds to sell securities below the mark-to-market price in order to meet large redemptions or maintain ...

Is it worth putting money in a money market account? ›

If you want to maximize how much interest you earn on your savings, a money market account can be a good option compared to other savings accounts because it usually earns a higher rate of interest. Plus, if you need quick access to your money, you can do so in a variety of ways.

Do you pay capital gains on a money market fund? ›

The earnings from money market funds can come from interest income or capital gains, so they're taxed the same way as other investment income.

How much will $10,000 make in a money market account? ›

A money market fund is a mutual fund that invests in short-term debts. Currently, money market funds pay between 4.47% and 4.87% in interest. With that, you can earn between $447 to $487 in interest on $10,000 each year. Certificates of deposit (CDs).

What is better than a money market fund? ›

Alternatives to money market funds, money market accounts, and savings accounts include: Certificates of deposit: CDs are term-based savings accounts that lock up your funds for a set time period in exchange for higher interest rates.

Has anyone ever lost money in a money market fund? ›

However, this only happens very rarely, but because money market funds are not FDIC-insured, meaning that money market funds can lose money.

What is the biggest disadvantage of money market? ›

Some disadvantages are low returns, a loss of purchasing power, and the lack of FDIC insurance. A money market fund can be ideal in some situations and potentially unwise in others. If you're close to or in retirement and need some of your money soon, a money market fund can make sense.

Are money market funds safe during a market crash? ›

Money Market Funds Offer Stability With Minimal Growth

However, money market funds provide investors with stability, even during market volatility.

What is the safest type of money market fund? ›

U.S. government money market funds are typically regarded as the safest of the three, and within that category, those with a high concentration of Treasuries—with full government backing—would be exposed to a lower likelihood of default risk.

How long should you keep money in a money market fund? ›

Some money market accounts require minimum account balances for the higher rate of interest. Six to 12 months of living expenses are typically recommended for the amount of money that should be kept in cash in these types of accounts as emergency funds. Beyond that, not investing will mean missing potential earnings.

Is there a penalty for closing a money market account? ›

Are there any restrictions or penalties when closing a Money Market Account? There are no restrictions or penalties when closing a Money Market Account. If you close your Money Market Account before dividends are credited at the end of the quarter, you will receive closing dividends.

What are the risks of money market funds? ›

You could lose money by investing in a money market fund. An investment in a money market fund is not a bank account and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.

Do you get a 1099 for a money market account? ›

Interest generated by a money market account is considered taxable interest income. Any year that interest is more than $10 you'll receive a 1099 INT interest income statement at year-end.

What is the 7-day yield on a money market fund? ›

The 7-Day Yield represents the annualized fund yield based on the average income paid out over the previous seven days assuming interest income is not reinvested and it reflects the effect of all applicable waivers. Absent such waivers, the fund's yield would have been lower.

Is a money market fund better than a fixed deposit? ›

Money market funds aim to provide a high level of liquidity and low levels of risk while offering returns higher than traditional savings accounts. They are a good option for investors who want to keep their investments liquid and safe, while earning a higher return than what is offered by fixed deposits.

What is the average interest rate for a money market account? ›

You will often find money market accounts that earn according to a balance tier. This simply means that your exact interest rate depends on your account balance, with higher balances usually earning at a higher rate. Average money market rates fall between 0.01% APY and 3.45% APY, again depending on your balance.

What is the disadvantage of investing in a fund of funds? ›

Disadvantages of investing in FOFs

Investors might face the fees associated with the FOF itself and the fees of the underlying funds within the portfolio. These cumulative expenses can eat into overall returns, potentially reducing the net gains for investors.

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