Personal Finance: The basics of money market funds
Yet most investors know relatively little about how they are constructed and managed. Today, in another installment of our occasional series on investment securities, we take a look at these popular repositories for idle cash.
Before the 1970s, cash balances languished in low-yielding bank or brokerage accounts while awaiting redeployment into another investment. In 1971, the brokerage industry created a particular variety of open-ended mutual fund specifically tailored to attract short-term cash balances. Unlike bank accounts, whose interest rates represented the cost of deposit capital for lending, money market funds invested their customers' funds into other interest-bearing instruments like
In response, a 1983 banking reform bill opened the door for banks to offer their own,
Over time, a large variety of money funds has developed offering investors a panoply of options regarding taxation, yield and relative risk. As noted above, early offerings generally stuck to good old
Bear in mind that the range of potential returns among these funds is relatively narrow, as they are all intended to serve as a parking place for uninvested cash. Most brokerages specify a default selection of money fund, often a version offered by a banking affiliate. You must make an affirmative decision to seek out a higher-yielding alternative, and may have to place an order to purchase the shares instead of enjoying an automatic sweep.
Most money market funds are constructed very much like most open-ended mutual fund with one important exception: the funds typically attempt to peg the price of shares at
During the 2008 financial crisis, the calm waters were roiled when a prominent fund company lost money on the investments in the fund and allowed the value of its shares to dip below the
Money market funds have become widely accepted as a convenient and (slightly) higher-yielding alternative to traditional bank deposits. Given their ubiquity, it is important to know the basics.
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