According to the mutual fund industry trade group Investment Company Institute, roughly $60 billion flowed out of money market funds, or MMFs, in the week ending July 16. However, total money market fund assets reached an all-time high of $8.3 trillion in May, and they stood only slightly lower ($7.9 trillion) as of mid-July.
[Sign up for stock news with our Invested newsletter.]
What Are Money Market Funds?
MMFs invest in short-term assets and securities such as cash, cash equivalents and highly liquid, near-term instruments.
U.S. Treasury and government securities MMFs include investments such as:
— U.S. Treasury bonds
— Repurchase agreements (short-term government securities)
— Cash
Prime MMFs generally offer an advantage in yield due to their investments in:
— Bank acceptances (short-term debt guaranteed by commercial banks)
— Commercial paper (unsecured short-term corporate debt)
— Certificates of deposit
MMFs are designed to generate higher yields than bank savings accounts or money market savings accounts. They are most suitable for investors who are seeking to preserve capital, maintain liquidity and earn dividend income. Thus, if an individual wants to invest funds they will need in a short time span, a money market fund could be a viable option.
MMFs generate income, but little to no capital appreciation. As a result, MMFs are not considered suitable for long-term investments, but rather as a short-term place to park cash.
The income generated can be taxable or tax-free depending on the underlying investments. A fund distributes excess earnings from interest as dividends. Investors like MMFs because the fund managers have to make regular payments to the investors, which allows for a steady stream of income.
History of Money Market Funds
MMFs have been around since the early 1970s. In 1970, Bruce Bent and Henry Brown established the first MMF called the Reserve Primary Fund. Considered a low-risk investment, MMFs gained traction because of their stated goal of maintaining a net asset value, or NAV, of $1 per share. This enabled smaller investors to have a safe place to park cash in the short term, while earning a higher return on their investments than they would with interest-bearing bank accounts.
Since the early success of the Reserve Primary Fund, MMFs have been considered safe havens in times of market volatility. Nearly every 401(k) plan in the nation includes money market funds in the cash category, sometimes as the only cash option available.
Breaking the Buck
MMFs were started with the premise that the NAV would remain constant at $1 per share. If the NAV went below $1, it was referred to as “breaking the buck.”
Breaking the buck can occur when:
— Interest rates are too low for the fund to cover operating expenses or losses.
— Underlying investment values fall.
— Leverage is used, introducing new capital risk.
— Too many investors attempt to withdraw funds too quickly.
Since inception, the first incident of breaking the buck occurred in 1994, when the Community Bankers U.S. Government Money Market Fund was liquidated because of large losses in derivatives. The Investment Company Institute noted that, while this was the very first case of a fund breaking the buck, investors still received 96 cents of every dollar invested. This result generally appeased the public in terms of acceptable losses.
No additional incidents occurred until 2008, and the very first money market fund was gravely impacted. Investors in the Reserve Primary Fund were rattled to learn that the fund had $785 million in Lehman Brothers commercial paper. While this only represented about 1.5% of their total holdings, the intense media coverage of Lehman’s corporate bankruptcy created conditions causing the fund’s NAV to fall to 97 cents per share. As the financial markets melted down, fund managers announced that customers might lose money. This created a significant run on assets, which ultimately caused regulators to force the venerable fund to close its doors.
As MMFs have grown significantly in size and importance in retirement plans, institutional investors and corporations make up the bulk of investors. This is because the slightly higher rate offered, especially in prime money market funds, can represent millions of dollars to large investors. Additionally, MMFs tend to have fewer restrictions on withdrawals, adding to their liquidity value.
In 2020, short-term interest rates were driven to nearly zero to combat the global COVID-19 pandemic. This caused many MMFs to change strategy in order to avoid closing down, taking actions such as waiving fees in order to hold yields above zero. Unfortunately, some funds still had to close their doors.
[Read: How the Stock Market Works]
MMF Risks and Protections
It is important to understand that money market funds are generally considered to be safe investments, but safe does not mean that they are risk-free. Therefore, understanding the pros and cons of any investment takes on a special importance with MMFs.
Unlike money market savings accounts offered by banks, MMFs do not offer Federal Deposit Insurance Corp., or FDIC, protection. Thus investors, while they can typically expect a slightly higher return, are taking an additional risk, since funds are not insured against losses.
However, institutional prime and tax-exempt money market funds are no longer legally required to keep their NAV share prices at or above a dollar. These funds generally must pay redemptions within 7 days, though emergency exceptions exist now. Non-government MMFs may charge liquidity fees for withdrawals. Additionally, when a money market fund waives fees in order to keep yields high, they may recoup these losses at a future date if their waiver agreement includes a recoupment clause.
Past incidents of breaking the buck prompted the Securities and Exchange Commission (SEC) to create new regulations to better protect potential investors:
— In 2010, the SEC issued a series of new rules to provide more stability and resilience to managing risks.
— In 2016, the SEC required institutional prime and tax-exempt MMFs to let their NAV float, meaning it could move above and below $1 per share. This gave those funds more latitude to deal with adverse conditions without generating a run on assets. However, retail and U.S. government MMFs are still required to maintain the $1 per share NAV standard.
— In 2023, the SEC increased minimum liquidity requirements for money market funds and removed provisions of a rule that allowed MMFs to temporarily suspend redemptions through a gate. The SEC also required institutional prime and tax-exempt MMFs to impose liquidity fees when daily net redemptions exceed 5% of net assets and liquidity costs exceed a de minimis threshold (0.01%).
Future Growth in MMFs
Money market funds will continue to be in the news, due to their popularity in high-interest-rate environments. ESG (environmental, social and governance) criteria also found a niche through sustainable prime funds that allowed institutional investors to align short-term cash with corporate sustainability goals.
ESG itself is a framework corporations use to evaluate environmental practices, executive compensation and diversity initiatives. While most ESG efforts are focused on long-term measures, ESG found additional space within short-term instruments like MMFs, a notable shift in corporate strategy.
However, ESG’s role in portfolios has seen major regulatory shifts across presidential administrations. President Donald Trump rolled back Biden-era rules regarding ESG considerations in retirement planning in his second term. For instance, in June, the Department of Labor proposed a rule that would restrict fiduciaries from prioritizing ESG and diversity, equity and inclusion when picking investments and exercising shareholder rights.
Proper Understanding of MMFs Is Key
Money market funds’ chief competitive advantage is to offer what is historically considered a short-term haven for liquid assets to combat market volatility and generate steady income. It is possible to lose money in these investments, and those losses are not backstopped by FDIC protections.
Thus, all investors should be sure to read the fine print. Additionally, many people would find the services of a professional financial planner invaluable to avoid emotional investment decisions, especially when the markets are moving quickly in response to global conditions.
More from U.S. News
The Best Vanguard Money Market Funds
5 Best Schwab Money Market Funds
9 Best Mutual Funds to Buy Now
Money Market Funds: What Are They and How Do They Work? originally appeared on usnews.com
Update 07/20/26: This story was published at an earlier date and has been updated with new information.
