Money Market Funds vs. Fixed-Income Funds

No one can blame you for seeking certainty for your investments in a murky financial environment -- you need some return on your money. Get both safety and yield by investing in money market funds or fixed-income funds. "Fixed income" is investor lingo for bonds. Money market funds invest in government securities and some bank debt. Compare your opportunities in money market funds to bond funds before locking away the money you're keeping safe.

Money market funds invest in the short-term debt of the United States government: This means treasury bills, which mature much sooner than treasury bonds. The short-term nature of this investment allows the fund to adjust to rising interest rates. When the fund gets its money back from short-term investments, the money manager can quickly reinvest the money in T-bills that pay higher interest. Your money remains relatively safe because the investment is backed by the U.S. Treasury, and your income goes up as interest rates rise.

You pay for safety. The lower the risk on an investment, the lower your chances of making high returns. Money market funds tend to pay less interest than bonds. Before considering how to get the highest yield possible, the primary purpose of any money market fund is to preserve capital. In practice, this means the yield remains extremely low, just barely above what you would get in a savings account at your bank.

When a fund invests in bonds, it gets a higher yield than money market funds. Bonds can include government bonds and corporate bonds. If you choose a government bond fund, your investment is backed by the credit of the U.S. government. If you choose a corporate bond fund that invests in high-quality bonds, you have the assurance that the fund has chosen stable, reliable companies to invest in.

Compared to money market funds, you sacrifice some safety with fixed income. If interest rates begin to rise, the bonds in the fund can lose value: Because new bonds will pay higher interest rates, investors will view the lower-interest bonds as less valuable. If you choose a corporate bond fund, you're counting on the corporations to honor their commitment to pay interest on the bonds. Corporations do fail, and even those that succeed can have such financial trouble that they default on their bond interest payments.

On the fixed-income side, you can find long-term and short-term bond funds. Long-term bond funds run the greatest risk of losses in an environment of rising interest rates, because they're locked into bonds that may end up paying a lower interest rate than new bonds. While short-term bond funds run a similar risk, the short-term nature of their holdings means their bonds will mature soon and the fund can purchase higher-paying bonds. Medium-term bond funds run risks that lie somewhere between those for long- and short-term funds.