Mutual Funds vs. Money Market Funds: An Overview
Mutual funds and money market funds are two options for investors, whether the objective is a short-term financial goal or long-term wealth. The most important difference between the two is the degree of risk that the investor takes on.
A mutual fund invests money in a selection of securities, mainly stocks and bonds. Thousands of funds are available to investors, and they range from funds that buy highly speculative stocks to funds that are devoted to blue-chip stocks, high-quality bonds, or some of each. In any case, the investor accepts a degree of risk of lost principal. On the other hand, a money market fund is a type of mutual fund that invests only in ultra-safe investments, such as Treasury securities that are guaranteed by the U.S. government. Only a disaster of unprecedented proportions could jeopardize your principal. However, with the low risk comes a lower reward.
Key Takeaways
- Mutual funds and money market funds are both pools of money invested by professional money managers.
- There are thousands of mutual funds available, and their risks vary widely from blue-chip conservative to highly speculative.
- A money market fund invests only in low-risk short-term debt such as Treasury bills.
- Money market funds value the safety of principal over the chance of high profits.
Mutual Funds
A mutual fund is a pooled fund. The contributions are combined to enable the fund managers to give each investor exposure to a variety of investments. Their investors can accurately say that they have money invested in, for example, oil, gold, and banking. That's a breadth that most individual investors would not be able to mimic.
A mutual fund may include investments in company stocks, corporate bonds, municipal bond issues, or government treasuries. Many funds invest in some combination of these financial instruments.
An investor considering a fund should look at the expense ratio, which is the percentage of assets deducted yearly for fees.
Mutual funds are professionally managed. That comes at a cost to the investor in fees that are deducted from the account. The fees vary widely among investment companies. They also vary among funds, with higher fees generally associated with the most actively-managed funds. In addition, companies charge fees for advertising, administration, and other costs.
An investor considering a fund should look at the expense ratio. That indicates the percentage of an investor's assets that are deducted yearly for all fees.
In any case, the goal of a mutual fund is to outperform the market through active management investment strategies. "The market" in this case varies, with each fund aiming at a relevant benchmark. A technology-heavy fund, for example, may seek to outperform the NASDAQ Index or the S&P North American Technology Sector Index. When the investor gets the fund's financial report, its performance will be compared to that index.
Money Market Funds
Money market funds focus squarely on preserving principal and achieve that by investing only in short-term Treasury securities and other low-risk liquid investments. All of their investments are in interest-paying debt, but it's low-risk debt.
Money market accounts aim to hold the net asset value of each share at $1 while creating a steady, though relatively low, return in interest for investors.
Expense ratios are relatively low for money market accountsbecause they are not as actively managed as stock mutual funds. The sales loads required to purchase money market funds also are low or nonexistent.
Active investors often use money market funds as a holding account for money that is soon to be invested and for money generated from the sale of other securities.
FAQs
If you ask for easy access to your money and want the safety of FDIC insurance, a money market account may be the better option. However, a mutual fund may be the way to go if you want higher potential returns.
Is there a downside to money market funds? ›
Disadvantages of money market accounts may include hefty minimum balance requirements and monthly fees — and you might be able to find better yields with other deposit accounts.
Should I put all my money in a money market fund? ›
Is a money market fund a good investment? While money market fund yields are rising as they benefit from the Federal Reserve raising interest rates, money market fund investments aren't ideal for long-term investing, as the returns tend to be much lower than stocks and bonds.
What is the most important advantage of a money market mutual fund ____________? ›
Money market mutual funds provide investors with liquidity. That's because these funds are invested in securities that mature in short periods of time and can be liquidated for cash.
Is there a better investment than mutual funds? ›
Mutual funds and ETFs may hold stocks, bonds, or commodities. Both can track indexes, but ETFs tend to be more cost-effective and liquid since they trade on exchanges like shares of stock. Mutual funds can offer active management and greater regulatory oversight at a higher cost and only allow transactions once daily.
Are money market funds safe in a recession? ›
Money Market Funds
Ultra-conservative investors and unsophisticated investors often stash their cash in money market funds. While these funds provide a high degree of safety, they should only be used for short-term investment. There's no need to avoid equity funds when the economy is slowing.
Is it possible to lose money in a money market fund? ›
There is no direct way to lose money in a money market account. However, it is possible to lose money indirectly. For example, if the interest rate you receive on your account balance can no longer keep up with any penalty fees you may be assessed, the value of the account can fall below the initial deposit.
Are money market funds safe in a crash? ›
The Bottom Line. Both money market accounts and money market funds are relatively safe, low-risk investments, but MMAs are insured up to $250,000 per depositor by the FDIC and money market funds aren't.
How much money should you keep in a money market account? ›
Some money market accounts come with minimum account balances to be able to earn the higher rate of interest. Six to 12 months of living expenses are typically recommended for the amount of money that should be kept in cash in these types of accounts for unforeseen emergencies and life events.
Can you lose principal in a money market account? ›
Since money market accounts are insured by the FDIC or the NCUA, you cannot lose the money you contribute to the account—even in the event of a bank failure. You can, however, be subject to fees and penalties that reduce your earnings.
If interest rates increase, the value of a money market fund's investments generally declines, and vice versa.
What is the safest type of money market fund? ›
U.S. government money market funds are typically regarded as the safest of the three, and within that category, those with a high concentration of Treasuries—with full government backing—would be exposed to a lower likelihood of default risk.
Which is better money market or mutual fund? ›
Money market funds are generally considered to be a very safe haven for your cash. They are much less risky than mutual funds that invest in stocks. However, they are not federally insured and investors can lose money.
What are the disadvantages of a money market fund? ›
Some disadvantages are low returns, a loss of purchasing power, and the lack of FDIC insurance. A money market fund can be ideal in some situations and potentially unwise in others. If you're close to or in retirement and need some of your money soon, a money market fund can make sense.
Why do investors prefer mutual funds? ›
One of the primary benefits is diversification, which reduces the risk of loss by spreading investments across a wide range of assets. Mutual funds also provide professional management, allowing you to leverage the expertise of fund managers who make investment decisions based on their research and analysis.
Do mutual funds outperform the market? ›
Do mutual funds outperform the stock market? The study found that most actively managed mutual funds do worse than their benchmark index during most calendar years and over the long run. Notably, low-cost stock and bond index funds generally offer more predictable returns and lower costs than actively-managed funds.
Which is safer, a CD or a money market account? ›
CDs and money market accounts are both safe ways to earn more interest on your cash. With a CD, you can get a higher interest rate if you can leave the money untouched for a fixed term.
Is my money safe in a money market account? ›
Like other deposit accounts, money market accounts are insured by the FDIC or NCUA, up to $250,000 held by the same owner or owners. Money market accounts tend to pay you higher interest rates than other types of savings accounts.
