How to use money market funds in your portfolio

Money market funds are mutual funds that invest in short-term debt instruments with high credit quality, including US Treasury bills and short-term unsecured corporate-backed notes (aka commercial paper). Money market funds aim to sustain a net asset value of $1.00 per share while offering higher yields than bank savings accounts.

What are the advantages and risks of using a money market fund?

Money market funds are popular with both individual savers and corporations, who often use them as a tool for managing the cash on their balance sheets. They are available through any major brokerage platform and often offer features such as check writing, making them easy to use for larger expenses such as tax payments and major purchases. Shareholders in money market funds can easily transfer assets to or from a bank account or a longer-term investment vehicle.

Taxable money market funds account for the bulk of money market fund assets. They invest in taxable securities such as Treasury bills, other short-term government obligations, and other high-quality, floating-rate debt such as commercial paper. Their holdings typically have pristine credit quality.

All three types of holdings have very short maturities (with bonds coming due in weeks or months). As a result, they take on little to no interest rate risk. Because maturities are so short, portfolio yields quickly respond to changes in prevailing interest rates as bills mature and get replaced.

Money market funds are also safe because they generally don’t lose value. (There have been exceptions.)This safety comes at a price: they’ve had among the lowest returns compared with other types of assets. Because cash has no potential for capital appreciation, returns on money market funds are driven by  yield. Over the past 40 years or so, income returns for money market funds have ranged from a high of 13.4% in 1981 to a low of 0.01% in 2013 and 2014.

Past problems with money market funds

In contrast to bank accounts, which are insured by the Federal Deposit Insurance Corporation for up to $250,000 per depositor, per bank, money market funds don’t come with a guarantee.

And on occasion, money market funds have “broken the buck” by dropping below a $1.00 per share net asset value. In 1978, First Multifund for Daily Income took losses on some of its longer-maturity holdings as interest rates spiked and eventually liquidated at $0.94 per share. A similar problem arose in 1994, when Community Bankers U.S. Government Money Market Fund liquidated at $0.96 per share after suffering losses on interest rate derivatives as the Federal Reserve raised rates.

The biggest problems came around the global financial crisis. In 2007, several funds were exposed to defaults on commercial paper linked to subprime mortgages, but their sponsors stepped in to prevent their NAVs from dropping. In 2008, the Reserve Primary fund dropped to $0.97 per share thanks to Lehman Brothers’ default on commercial paper. And in 2020, several prime (institutional) money market funds suffered a liquidity crunch but maintained their $1.00 per share net asset values when the Fed created an emergency lending program to cover losses.

Recent reforms

In July 2023, the Securities and Exchange Commission adopted reforms meant to reduce the risk of future money market woes. Among other things, the SEC tightened liquidity requirements for money market funds’ portfolio holdings, eliminated automatic redemption “gates” tied to certain liquidity thresholds, imposed a mandatory liquidity fee for certain funds, and set new rules for disclosure and stress-testing.

Here are some of the most popular money market funds widely available to individual investors:

1. Fidelity Government Cash Reserves

2. Fidelity Series Government Money Mkt

3. Gabelli US Treasury MMkt I

4. Schwab Treasury Oblig Money Inv

5. Schwab US Treasury Money Investor

6. T. Rowe Price Government Money

7. T. Rowe Price US Treasury Money

8. UBS Government Money Market Invt P

9. Vanguard Federal Money Market Investor

10. Vanguard Treasury Money Market Investor

How much of my portfolio should be in a money market fund?

If you use a money market fund for cash management, the size of that position largely depends on your life stage. If you’re many years away from retirement, you don’t need to allocate much to cash, assuming you already have an emergency fund.

Closer to retirement age, financial advisors typically recommend keeping at least one to two years’ worth of expenses in cash or other low-risk assets so you don’t have to sell stocks or bonds when the market is down.

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This article was provided to The Associated Press by Morningstar. For more personal finance content, go to https://www.morningstar.com/personal-finance.

Amy C. Arnott, CFA, is a portfolio strategist for Morningstar and co-host of The Long View podcast.

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