Money market funds can help you accomplish some of your goals and can play an important role in a diversified portfolio. They should represent only a portion of your investments, which might mean as little as 5% in an aggressive portfolio or as much as 15% in a conservative portfolio. To decide how much to allocate, first think about your goals.
Uses in Your Portfolio
Money market funds provide easy access to your money. You generally can withdraw money anytime penalty free, and many funds offer check-writing privileges. They are also a good choice for short-term investments. For example, you can use a money market fund to build an emergency account with at least three to six months of your living expenses, giving you a reserve for the unexpected. You also might anticipate a large expense and want the potential for modest growth until you need the money.
Money market funds can provide a conservative element to your portfolio, adding stability, because they seek to preserve your principal by maintaining a stable share price.
An investment in a money market fund is neither insured nor guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.
If you’re anxious about stock and bond market volatility, holding a portion of your investments in a money market fund also provides a convenient place to keep money to use when you rebalance the asset allocation in your portfolio.
Many Funds; Many Securities
Money market funds invest in short-term debt securities that mature in one year or less. There are a variety of money market mutual funds and many types of securities that the U.S. government and its agencies, corporations and state and local governments issue. Be sure to read a prospectus to learn more about the specific securities in which a fund invests.
You may want to consider the tax implications of money market funds before investing.
Tax-exempt money market funds primarily invest in securities that a state or municipality issues. These funds can be beneficial for investors in a high tax bracket since income from these funds generally is exempt from federal income tax. However, income may be subject to state and local taxes and the federal Alternative Minimum Tax.
Keep in mind, municipal money market funds typically are unsuitable for tax-deferred investment accounts, such as IRAs or 401(k) plans, because of their tax-exempt status.
Taxable money market funds generally invest in short-term government or corporate securities. They tend to offer higher yields than tax-exempt money market securities. However, you’ll pay taxes on income from the funds.
How to Compare
To compare the return of a tax-free money market fund with one that is taxable, review American Century’s taxes calculator (americancentury.com/workshop/tools.jsp) to determine the tax-equivalent yield. Also, compare fund expenses and minimum balance requirements, which vary among funds, to determine the best investment for you.
Comparing Money Market Funds and Bank CDs
Some investors compare money market funds to bank Certificates of Deposit (CDs) when analyzing conservative investments.
Consider the differences before investing. CDs pay a fixed interest rate for a specific time period. You must invest your money for the full period to receive the full interest payment, and you usually will be penalized for early withdrawal.*
Money market funds don’t pay a fixed rate of return. You benefit from a higher return as interest rates rise but may have a lower return when interest rates decline. You have easy access to your investment, with no penalties associated with withdrawals before a specified date.
The FDIC insures CDs offered through banks, but only up to $100,000. Money market funds aren’t FDIC-insured but provide a high degree of safety because of the quality securities in which they invest.
If you’re looking for stability and the opportunity to access your money when you need it, money market mutual funds can be a good addition to your portfolio. Consider what role you want a money market fund to play in your portfolio and adjust your asset allocation to fit your investment goals.
* Early withdrawal from a CD causes a minimum penalty of seven days’ interest. Maximum penalties are up to the discretion of each financial institution and can vary.
This information is for educational purposes only and is not intended as investment or tax advice.
This article is from the Financial FYI® series produced by the Education & Guidance department of American Century Investments. "Financial FYI" is a registered mark of American Century Services Corporation.