What Are Money Market Funds?

Summary

This video explains money market funds (MMFs) and their role in short-term investing. MMFs are low-risk, cash-like investments that offer modest returns, primarily by holding high-quality, short-term debt such as government bonds, commercial paper, and certificates of deposit. The video highlights the safety features of MMFs, including high credit quality and short maturities, and explains how returns track benchmark rates like SONIA. It also covers qualified money market funds, potential price fluctuations, and the risks of long-term holding. Overall, MMFs are ideal for storing cash safely over short periods while providing liquidity and modest interest income.

Takeaways

• 💰 Money market funds are used to hold cash over a short period of time and generate a small rate of return similar to a bank account.
• 🏦 Unlike some bank deposits, money market funds can be sold at any time, offering high liquidity.
• ⚖️ Investment involves a tradeoff between risk and return, with money market funds being low risk and low return.
• 🛡️ Money market funds are considered safe because they invest in high credit quality companies and short-term debt.
• 📉 They primarily hold short-term government bonds, commercial paper, and certificates of deposit to maintain stability.
• 📜 Qualified Money Market Funds (QMMFs) follow strict regulatory rules to keep their net asset value stable and maintain liquidity.
• 📆 Investments in QMMFs typically mature in no more than 30–97 days with an average maturity of 60 days or less.
• 📊 UK money market fund returns are often benchmarked to the Sterling Overnight Index Average (SONIA), which tracks the Bank of England policy rate.
• 📈 Money market fund returns fluctuate with central bank interest rates, rising when rates increase and falling when rates decrease.
• ⏳ Long-term holding in money market funds can lead to underperformance compared to equity funds due to their low returns.
• 🔍 Different types of money market funds may have price fluctuations, especially income or slightly longer maturity funds, so understanding the fund's behavior is important.
• 💡 Money market funds are best used for short-term cash storage rather than long-term investment growth.

Q & A

What is a money market fund (MMF) and what is its primary purpose?

A money market fund is an investment vehicle used to hold cash over a short period of time. Its primary purpose is to provide liquidity and a small return while maintaining low risk.

How do money market funds compare to other investment types in terms of risk and return?

Money market funds are low-risk, low-return investments. They are generally safer than stocks, bonds, and alternative investments because they invest in high-credit-quality, short-term debt.

What types of investments do money market funds typically hold?

They typically invest in UK short-term government bonds, US commercial paper issued by high credit quality borrowers, and short-term bank deposits called certificates of deposit.

What are qualified money market funds (QMMFs) and what rules govern them?

Qualified money market funds are regulated to ensure they are cash-like. They must maintain a stable net asset value, invest in short-term assets (≤397 days, average ≤60 days), and remain highly liquid.

How do money market funds maintain low risk?

MMFs maintain low risk by investing only in high credit quality borrowers and ensuring that their debt matures quickly, minimizing exposure to price fluctuations and default risk.

What is SONIA and how is it related to money market fund returns?

SONIA (Sterling Overnight Index Average) is the rate at which banks lend to each other. Many UK money market funds benchmark their returns to SONIA, so their income closely tracks changes in the Bank of England policy rate.

Why is the return on money market funds generally low?

The return is low because MMFs prioritize safety and liquidity over high yields, investing in short-term, high-quality debt instruments that generate modest, cash-like returns.

What are the risks associated with holding money market funds long-term?

Holding MMFs long-term can result in underperformance compared with higher-risk investments like equities, as their returns are relatively low and may not keep pace with inflation or stock market growth.

How do accumulation and income versions of MMFs differ?

Accumulation funds reinvest income, causing the fund price to steadily increase, while income funds pay out income periodically, which can cause temporary price dips after payouts.

Why is it important to check the price behavior of a money market fund before investing?

Because some MMFs' prices can fluctuate slightly with interest rate changes or income payouts. Understanding price behavior helps investors avoid surprises and choose the right fund type for their needs.

Can money market funds be sold at any time?

Yes, money market funds are highly liquid and can generally be sold at any time, unlike certain bank deposits which may lock in money for a set period.

How did the Bank of England’s policy rates from 2020 to 2022 affect MMF returns?

During 2020–2022, the Bank of England set rates to near zero, so MMF returns were flat. When rates increased in 2022 to curb inflation, MMF returns rose correspondingly.