A money market fund is a type of low-risk mutual fund investment that holds mostly short-term public and private debt.
Mutual funds aim to grow the cash placed them by investors, usually by owning stocks and bonds. A money market fund, in contrast, is designed to maintain the value of the investment. While not risk-free, these funds are highly liquid and typically pay a higher return than a standard bank savings account.
Investors often use a money market fund to park cash they intend to reinvest in a short period of time, such as incoming dividend and interest payments and their own contributions.
Money market funds own short-term debt issued by highly rated governments and corporations. Those institutions in turn have come to rely on the money markets for access to cash for immediate purposes, rather than taking cash from their own operations.
A money market fund seeks to keep its net asset value (NAV) at $1, meaning every dollar invested by an individual can be redeemed for $1 at any time.
If you have a brokerage account, you probably have a money market fund as part of your account. The investment company typically is not a bank, although some approximate bank services. As result, cash coming into your account from you or from an investment you own has no place to be held in the short run.
You likely expect your contributions or incoming cash to be reinvested in short order. If you set your investments to reinvest automatically they will, so cash is not an issue. However, some investors consider holding cash an important part of their portfolio design, or they choose to invest only periodically or to reinvest into different assets.
In that case, the cash is placed in a money market fund. The fund maintains the value of your money and pays a return that is usually more favorable than you would otherwise expect from putting cash in a bank. Plus it’s available to reinvest at any time.
A “prime” money market fund owns highly rated public and private debt. There are tax-exempt money market funds that invest in municipal bonds, and some money market funds only buy U.S. Treasury debt.
Money market funds are low risk but not risk-free. Over the decades of their use, only a few have “broken the buck” and reported a net asset value of under $1. Generally, those failures were resolved successfully by the funds themselves or, in the case of 2008, with the financial backing of the U.S. government.
A long-term retirement investor typically will not be faced with risk in any case. Dollar cost averaging, the practice of steadily investing contributions and incoming interest and dividends, usually means your brokerage account will show no or very little cash on hand.
As you take money out of a retirement account as income, the cash also spends very little time in a money market fund. Often, the brokerage will issue you a check in short order, so the money market exists essentially to hold the money overnight while the firm prints and mails out the requested distribution.