Pros and Drawback of Money Market Funds

Aug 18, 2022 By Triston Martin

Investors should be aware of the advantages and disadvantages of money market funds. The ups and downs that have occurred will be discussed in detail.

What are the pros and cons of money market funds compared to other investment options? The Foundations of Money Market Accounts It's not uncommon for money market investments to provide returns in the low single digits. Compared to the risk associated with equities or corporate debt, the chance of the initial investment is far lower. Nevertheless, potential buyers need to weigh several advantages and disadvantages. Unfortunately, the drawbacks usually outweigh the benefits.

Advantages of Putting Money in Money-Market Accounts Let's begin with the benefits of a money market account.

Deposit Your Money

In times of extreme stock market volatility and uncertainty, the money market provides a haven for your savings. Why? It has already been said that money market accounts and funds are commonly considered to be more secure than their stock and bond counterparts. Because these funds typically invest in certain assets like checking accounts, government bonds, and short-term commercial paper, they are considered low risk. Furthermore, even in a weak market, investors can expect returns in the low single digits from the money market.

There is typically no issue with liquidity

Money market funds generally do not put their money into securities that are hard to sell or are not widely held. Instead, they prioritize dealing in products widely anticipated to be in high demand (such as T-bills)—the ease with which they can be bought and sold shows that they are more liquid. As an alternative, perhaps investing in the stock of a small-cap Chinese biotech firm might be a more intelligent move. In some instances, there could be a sizable market for such supplies, but in most cases, it would likely be pretty tiny. Buying or selling at the right time could be complex in a down market.

If an individual's assets in the money market do not generate sufficient returns to pay rising living expenses, that individual's purchasing power may fall over time. Risks Associated with Investing in the Money Market Now, we'll look at the downsides of MMAs.

One's Purchasing Power May Fall An investor loses purchasing power annually if inflation is 4% and their money market account interest is 3%.

Constraints on Resources

When investors make 2% or 3% per year on a money market account, even a small annual fee can eat a sizable chunk of the profits. This may make it even harder for money market investors to keep up with inflation. Costs reduce returns in different proportions for different accounts and funds. For instance, if an individual invests $5,000 in a money market account producing 3% annually and is charged $30 in fees, the individual's return on investment will be drastically reduced.

Only $150, or 3%, of $5,000 is considered a significant amount. The $30 in fees is 20% of the total yield, a sizeable portion taken from the net earnings. Possible additional taxation in the absence of a retirement account where the transaction could be performed is not factored into the figure mentioned above. It's Possible That There Won't Be an FDIC Safety Net

The FDIC's insurance program protects deposits up to $250,000. However, money market mutual funds are rarely supported by the state.

Investors should be aware that despite money market mutual funds' perceived safety, they involve some risk. Investors who have $20,000 in a money market account at a bank that goes bankrupt would likely have their losses reimbursed by this insurance. If a fund were to engage in the same practice, however, the investor might not be able to regain their previous financial standing, at least not with the federal government's help.

Potential Payouts Cannot Be Promised at This Time

Even though money market funds typically invest in government securities and other vehicles that are generally secure, they may take some risks to achieve better rates for their investors. For example, the fund may earn an additional tenth of a percentage point by investing in bonds or commercial paper with a higher risk of default. A higher-yielding money market fund entails more risk. Therefore it may not always be the ideal choice.

It is also essential to remember that there are times when the alternatives to the money market are similarly subpar. A check in the mail for dividends or sales profits could not be as profitable for investors as investing the money yourself. Dividends reinvested in shares may exacerbate return problems in a down market.

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