Advantages and Disadvantages of Money Market Funds

Mutual funds are an investment fund that pools in money from various individual and institutional investors into one large giant fund that is managed by a financial expert or a team of professionals with a single objective in mind. These objectives differ in the range from low to high risk, fixed or flexible tenure, high to low liquidity, or even fixed investments like hedges or government projects. One such mutual fund is a money market fund. These funds focus on high liquidity, and low risk and are usually applied to cash-related investments or very short term commitments like government treasury bonds. These are generally handled by a private or semi-government financial investment company and share its objectives and plans with the public openly.

Classification of Money market funds

As money market funds have low risk, and high liquidity objectives, there are a limited number of instruments in which these funds can invest. Based on the product being invested in, these funds are categorized into 3 types.

1. Prime Money Fund – Funds that deal only in floating rate debt funds and commercial papers like exchange-traded funds
2. Government money funds – As the name suggests government securities and cash transactions are covered under this fund
3. Treasury fund – Debt securities like bills, bonds and notes are the only instruments utilized under treasury money market funds. They are also known as municipal funds.

Advantages and Disadvantages of Money Market funds

Although very liquid funds, there are a couple of factors that we need to be sure about to understand the long term benefits and drawbacks of a money market fund. The following points should help clear any doubts.

Advantages of Money Market Funds	Disadvantages of Money Market Funds
1. They are practically like a bank account with higher interest rates. We can earn considerably higher amounts of interest on a money market fund than on a regular savings account due to the low-risk nature of these funds.	1. High liquidity also means volatile opportunities. If the instruments that these funds invest in are withdrawn or cancelled in their term, the money market fund could lose the invested money very quickly and customers can even lose their invested capital.
2. Similar to the example above, these funds can be withdrawn almost at a day’s notice like an account with a bank. Because they are involved in short term securities and cash instruments, the liquidity is pretty high in money market funds.	2. Certain money market funds can request to lock in your money if the investment company wants to change the nature of the fund. Either one can withdraw all their funds or have their money locked in for two to three years at a time.
3. All earnings from the funds along with the fund itself is easily trackable and can be conveniently managed.	3. Although slow earners, waiting to see your money grow on Money market funds might mean missing out on other categories of mutual funds that can earn interest much quicker and double your investment in a matter of a few years.
4. The Securities and Exchange Commission (SEC) makes sure that the funds available in the market only invest in tried and tested instruments and have a proven track record of making good investment decisions. Any foul play can lead to tax and other penalties for the investment companies. In this sense, these funds are safer than similar funds.	4. These funds are not insured. For bank accounts and term deposits, FDIC provides for insurance upto $250,000 per customer. However, money market funds are not insured as the funds are not secured for any amount of time. This could be troublesome if the investment company is not able to manage the fund properly.
4. Due to the low-risk nature, these funds have almost a steady rate of interest that keeps growing slowly but steadily over a course of time. Over the course of years, these funds can provide high returns.	5. Although high returns are possible, these funds might not be able to beat inflation if the investment articles are not regulated often. For long tenures, the fund might earn high returns, but considering the time value of money, it might be on the lower side of returns.

Conclusion

Money market funds usually pay out dividends in the form of earnings. These dividends are taxed just like normal income. So these funds are not out of the purview of taxes. At the same time, the interest is almost fixed on these funds as the instruments that they are invested in are short term in nature and have steady payouts on maturity. Money market funds have been in circulation since the 1970s. Investment management companies cashed in on the securities and bonds market and opened their gates to customers to take a chunk of earnings from these sources in a secure and quick fashion. Most regular investors and industry front runners today chose to invest a part of their earnings into money market funds to capitalize on the low-risk portfolio and maintain a steady income that can be quickly accessed. It has come around to become one of the strongest financial investment tools in the present and is recommended to be used in moderation by first-time investors to the most seasoned financial stakeholders.