Investors often confuse money market accounts with money market funds. While their names are very similar, there are significant differences between these two investment options.
Another major difference between money market funds and money market accounts is who sells and regulates them. Money market funds are sold through brokers (not banks) and are therefore regulated by the Securities and Exchange Commission (SEC).
Unlike other types of mutual funds, money market funds are restricted by the SEC to only invest in debt instruments that are high quality and have short-term maturities.
A money market fund cannot hold anything with a maturity over 13 months and the average maturity of its investments must be under 90 days. These requirements are designed to make money market funds very safe. To help further decrease risk the SEC also requires money market funds to hold a diversity of investments, not investing more than 5% of the fund into any one instrument.
There are several type of money market funds:
Government Money Market Funds
These only invest in debt issued by the US Government or agencies backed by the US Government.
Tax Free Money Market Funds
These only invest in debt issued by municipalities.
Corporate Money Market Funds
These only invest in debt issued by corporations.
The ability to choose between the types of investments your money is placed in is another feature of money market funds that is not available with money market accounts.
Unlike other types of mutual funds, money market mutual funds also seek to maintain a stable net asset value of $1.
You can buy as many shares of the money market fund at $1 per share that you would like without effecting the price of a share. The value of a share does not change in value from $1 because the interest earned on the investments of a money market fund are paid out in the form of dividends (usually monthly). As long as the fund does not earn a negative return, you receive $1 back on your shares when you sell them as well.
If a money market mutual fund looses money, this is called “breaking the buck”.
If a money market fund breaks the buck, this means that investors will get back less than they invested in the fund. While this has happened in the past, in most cases the company that offered the fund has made up the difference, in order to avoid the damage to their reputation that would occur if they allowed investors in their fund to loose money.
Prior to the financial crisis in 2008, only 1 company in the almost 40 year history of money market mutual funds had investors which lost money in their fund.
In 2008 in order to prevent a run on money market mutual funds (some of which had lost large amounts on the debt of Lehman Brothers) the US government stepped in and insured all money market funds against losses. While there is no guarantee that the government would do the same in the future, the fact remains that money market mutual funds are considered by most to be one of the safest investments available.