Money market funds are funds that are managed by an investment manager, who invests in short-term, low risk investments, on behalf of their clients.
As money market funds are involved in low risk investments, the funds tend to invest in cash investments or bonds with a short timeframe.
The aim of a money market fund is to offer clients exposure to very low risk investments, with high liquidity. High liquidity means that investors are able to easily buy and sell their investment into the fund.
Retail money market funds are those that are offered to the general public. They are usually offered by banks or brokerage firms and have certain rules, such as having a minimum balance (such as £10,000).
Money market funds offer investors a return that is similar to the official interest rate, which varies from one country to another. Therefore, in many cases, money market funds offer very low returns for investors, between 1% to 2% per year.
For a lot of investors, money market funds would only be suitable in the short term. This is because they do not offer large return.
Instead, money market funds may be used by some investors when they have no use for the money that they have on hand. This could be because they are waiting for the market to go down further, in order to invest at lower prices, or simply because they have no other opportunities.
In those situations, an investor may prefer to invest their money into money market funds, instead of not earning anything at all.
Alternatively, money market funds would suit someone that has a very low tolerance for risk. Money market funds enable those people to earn a return that is very low risk, while helping them to offset some of the value lost in their savings by inflation.
For most investors, money market funds are not a long term solution. They should typically be used as a way to achieve some level of return when the investor doesn’t have use for some of their money.
There are four main types of money market funds. They are prime money funds, government money funds, treasury funds and tax-exempt funds.
Prime money funds invest in variable-rate debt (debt that changes with the official interest rate) and commercial paper (a short term debt issued by companies to cover short liabilities i.e. payroll).
Government money funds invest at least 99.5% of its money on cash investments, government securities (i.e. government bonds) and repurchase agreements (an agreement where the government sells debt to investors, only to buy it back the next day).
Treasury funds invest in debt investments offered by the Treasury in the United States. These include short term debt investments like treasury bills, bonds and notes.
Finally, tax-exempt funds invest in short term debt investments that have been issued by tax-exempt entities (i.e. charities). This allows the fund to offer a very low rate of interest that is tax free.
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