Choosing Money Market Mutual Funds

Mutual funds can offer the advantages of liquidity, diversification, professional management and a competitive rate of return.  A money market fund investment can help an investor reach their financial goals whether they are short term goals or long term, but as with many other types of investments, investing in mutual funds involves some level of risk.  Unlike bank deposits, the principal and payment of interest in money market funds are subject to some risk.  However, money market funds do have a very good record of capital preservation overall.  

The ability to convert the money market funds to cash for investment or pay bills provides an advantage that money market mutual funds have over other safe and secure individual security investments such as bank CDs.  Even though the income from money market mutual funds is usually taxed, since the money market funds maintain a constant net asset value unlike a individual stock or equity fund, money market funds can be bought or sold without being taxed.  Buying and selling individual securities or even bank CDs is not as simple as it is with money-market mutual funds.  Treasury bills and notes are liquid as also negotiable and liquid, but Treasury notes can drop in value and it may take at least three days to receive the funds from their sale in the secondary markets.  A potential disadvantage with the money market mutual funds is that during certain periods the short term rates in money market mutual funds are eclipsed by the rates offered by individual money market investments such as CDs or bank money market accounts.

Because of the potential for high yields, the ability to move the funds within a fund family and the ability to use the money in these accounts similar to checking accounts, money market funds have become prevalent investment channel for savings and cash resources for both investors with large portfolios and those investors who are just starting out.

Before an investor select a money market fund, it is important to review the individual’s investment goals and objective.  An investor can then decide the function that money market funds may play in an overall savings and investment strategy.  Money market fund allocations should be decided on similar to almost all savings and investment choices by looking at the individual’s investment time horizon, the specific investment goals such as starting a savings fund, building retirement income, safe and secure temporary investing, or similar objectives.

When choosing the money market investment, the most basic starting point is to put together a financial plan.  The plan should outline short and long term goals, assess acceptance for risk, and establish savings targets that fit the individual’s budget.  A successful investment strategy always requires a budget and a long term time horizon.  The basic building blocks of any investment strategy and portfolio are stocks, bonds or notes, mutual funds, and interest bearing liquid deposits.  As a rule, a diversified investment plan should include a mix of all four investment types.  Deciding how to allocate available funds allocate to each type of investment depends on an individual’s age, goals and the amount of risk they are willing to accept.  Establishing savings and investment goals with realistic expectations is always a solid starting point for evaluating investment choices.  Establishing goals will help assess how much money an individual needs to invest, how much the investments should or have to return, and the need for access to an income stream and the principal investments.
Depending on the features, bank CDs may be an appropriate investment for an investment portfolio.  Money funds are a solid choice to fit some aspect of an investment portfolio.  Money market mutual funds are purchased for a variety of reasons to fit individual investment goals.  Money market funds are used to help diversify an existing portfolio or provide a current income stream.  The money market fund is often used just as temporary storage between other fund investments.  And money market funds can be used as high yielding checking account used to assist in budgeting and paying high dollar amount monthly expenses.  In the later case, a money-market fund is essentially a cash account paying interest.  In this situation the money market fund is more liquid than the bank CDs. 

There are risks in a money market mutual fund, more than just the principal risk, which can be very difficult to evaluate completely and measure before investing.  One such risk is the lack of control over the underlying investments.  Investors typically cannot ascertain the exact make-up of a fund’s portfolio at any given time, nor can they directly influence which securities the fund manager buys and sells or the timing of those trades.
 
In addition there is price uncertainty in the underlying assets or debt instruments held by the money market mutual fund.  With an individual stock, an investor can obtain real-time or near to real-time pricing information with relative ease by checking financial websites or by calling a broker.  An investor can also monitor how a stock’s price changes from hour to hour or even more frequently if desired.  By contrast, with a money market mutual fund, the price at which you purchase or redeem shares will typically depend on the fund’s NAV, which the fund might not calculate until many hours after you’ve placed your order.  In general, mutual funds must calculate their NAV at least once every business day, typically after the major U.S. exchanges close.

This entry was posted on Tuesday, January 6th, 2009 at 1:20 pm and is filed under Mutual Funds. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.