Are you looking for the best investment instruments to grow your wealth? Luckily, you can use several types of savings options to keep money aside and grow it steadily. Mutual and money market funds are among them.
The difference between money market and mutual funds is slight because the two investment vehicles are related. Understanding what they are, how they work and their pros and cons will enable you to choose the best option for your needs.
Money Market vs. Mutual Funds: Definition
A mutual fund is a fund in which a company will collect money from multiple investors to form a portfolio. And the company will use it to buy securities, such as stocks, short-term debt and bonds.
A professional usually manages these investments and trades them with the aim of making more money. Investors will cede some of their funds to them as payment for their expert services. However, some funds are passive and do not require active management.
Typically, investors use their money to buy shares in the company. And their shares represent their ownership stake and the income the mutual fund makes. Dividends will be distributed monthly based on your shares. And the portfolio tends to include short-, long- and mid-term securities.
A money market fund is one type of mutual fund. It enables you to buy high-quality, low-risk securities, which tend to be short-term while producing decent returns. So, it is highly liquid because you can sell your shares at any time. Also, they tend to focus on specific but stable securities, which may include bank debt securities and government securities.
For example, a government money market fund has 99.5 percent of its portfolio in highly liquid investments, like government securities and cash.
Money Market and Mutual Funds: Valuation
Generally, government and retail money market funds use unique pricing strategies to keep their net asset value at $1 per share for stability. In this case, the net asset value (NAV) of a company refers to the total asset value minus the total liability value of a company. And then, the company divides NAV by the total number of shares outstanding to get the per-share value. At that rate, $2,000 worth of investment will likely give you 2,000 shares.
NAV is meant to be calculated daily for all types of mutual funds. So, it tends to change daily. In turn, that change affects the NAV per share on any given day. So, it requires special pricing strategies to keep that amount stable at $1 on any given day. It is worth noting, though, that institutional prime money market funds have a floating NAV that depends on the current market value of the securities they own.
The valuation of other mutual funds, such as bond, stock and target funds, varies widely. Some drastically increase the value of the portfolio due to their high returns.
Mutual Funds vs. Money Market Mutual Funds: Risks
All mutual funds lack the FDIC protection that safeguards investors from money loss if a financial institution holding their assets goes under. They also lack guarantees from other government agencies.The lack of insurance extends to mutual funds that banks issue or those that carry bank names even though banks are typically FDIC insured.
However, money market funds tend to concentrate on high-quality, low-risk investments. For that reason, they are likely to fare better than other kinds of mutual funds that focus on high-risk, high-return securities like bonds and stocks.
Money Market Funds vs. Money Market Accounts
Money market accounts are also worth a discussion since people tend to confuse them with money market funds. You may also know them as money market deposit accounts or money market savings accounts.
A money market account is an interest-bearing savings account that you can open in a credit union or bank. It provides liquidity, unlike certificates of deposit, which prevent you from cashing in your funds before maturity. So, you can use them to pay someone through checks or a debit card.
However, your withdrawals tend to be limited to six in any given year. And if you exceed that number, you may pay more in transaction fees.
It is also worth noting that many money market accounts require a minimum deposit and reward investors with higher interests if they save more. But such rules could be helpful if you want to save for a long time and lack the discipline to do so without motivation.
One significant difference between money market accounts and all kinds of mutual funds lies in the protection of your investments. When you save your money in an FDIC-insured bank or credit union, if the financial institution goes under, FDIC will protect your investments to the tune of $250,000.
Another difference is that you need much less money to open a money market account than a money market fund. As a result, the former is more accessible. Also, money market funds tend to pay a bit more than money market accounts. So, that’s something to think about.
Final Thoughts on These Funds
All money market funds are mutual funds, but not all mutual funds are money market funds. So it would be best to learn the slight differences. If you want a low-risk and liquid investment vehicle with decent returns, money markets offer you an excellent balance between the safe and relatively liquid money market accounts and the other kinds of high-risk, high-return and liquid mutual funds.
In the end, your risk tolerance will determine which investment vehicles make the most sense for your financial needs.
- Investor.Gov: Mutual Funds
- Investor.Gov: Money Market Funds
- Investor.Gov: Net Asset Value
- SEC: Mutual Funds and Exchange-Traded Funds (ETFs)
- Forbes: The Pros And Cons Of Money Market Accounts
- Time: Money Market Funds: Advantages and Disadvantages
- Business Insider: The key differences between a money market account and a money market fund, and how they each serve different financial needs
I hold a BS in Computer Science and have been a freelance writer since 2011. When I am not writing, I enjoy reading, watching cooking and lifestyle shows, and fantasizing about world travels.