The SEC’s Office of Investor Education and Advocacy is issuing this Investor Bulletin to help educate investors about money market funds.
What are money market funds?
Money market funds are a type of mutual fund that invest in liquid, short-term debt securities, cash and cash equivalents. Money market funds have relatively low risks compared to other mutual funds and most other investments, but historically have had lower returns. Money market funds pay dividends that generally reflect short-term interest rates. More specifically, the yield of money market funds changes over time and generally reflects changes in short-term interest rates. The yield is income that is distributed to shareholders as dividends which many shareholders reinvest into the money market fund. Many investors use money market funds to store cash or as an alternative to bank savings vehicles.
What types of money market funds are there?
Money market funds generally fall into three categories:
Government money market funds invest 99.5% or more of their total assets in very liquid investments. These investments include cash, government securities, and/or repurchase agreements that are collateralized fully with cash or government securities.
Tax-exempt money market funds (also referred to as municipal money market funds) generally invest 80% or more of their assets in municipal securities (e.g., state and local government bonds) whose interest is exempt from federal and/or state income taxes.
Prime money market funds primarily invest in a variety of taxable short-term corporate and bank debt securities, such as commercial paper and certificates of deposit.
Money market funds are generally structured to cater to different types of investors. Some funds are intended for retail investors and are generally limited to individual human beings. Other money market funds, which typically require high minimum investments, are intended for institutional investors.
Are money market fund shares always valued at $1.00?
Like all mutual funds, money market funds are redeemable on demand. This means that investors can generally sell their shares back to a money market fund on any business day at the net asset value (or “NAV”) per share. The NAV per share is the per share value of a fund’s assets minus its liabilities.
Stable NAV. Most money market funds – including money market funds intended for retail investors and government money market funds – seek to keep their NAV at a stable $1.00 per share. (A few money market funds seek to maintain a stable NAV per share of a different amount, like $10.00. For simplicity, this Investor Bulletin will discuss the stable NAV per share of $1.00.) Funds maintain a stable NAV by using special pricing and valuation conventions when valuing the fund assets. This means investors can generally buy and sell shares of these types of money market funds for $1.00.
Floating NAV. Institutional prime and institutional tax-exempt money market funds are not allowed to use these special pricing and valuation conventions. Instead, they must “float” their NAV like other mutual funds to reflect changes in the current market-based value of fund assets. This means that, although these money market funds still try to keep a fairly constant price, investors may buy or sell shares of these types of money market funds for more or less than $1.00 per share.
What are some risks of investing in money market funds?
For stable NAV money market funds.
- If a stable NAV money market fund’s NAV per share deviates by more than half a cent from $1.00, the fund must re-price its shares to something other than $1.00. This is known as “breaking the buck” and could happen when a money market fund is exposed to substantial losses from some of its holdings. If this happens during times of general turbulence in the financial markets, it could lead to a run on some money market funds. Although funds very rarely “break the buck,” if one does, the investor’s holding in the fund would lose value.
For floating NAV money market funds.
- As with other mutual fund investments, the value of floating NAV money market fund shares generally decreases or increases as the money market fund assets decrease or increase in value, respectively. If the value of the fund shares decrease, the investor’s holding in the fund would lose value.
For all money market funds.
- Historically, the returns for money market funds have been lower than for other types of mutual funds. Because the yield for money market funds can be low, there is a risk that inflation will outpace and erode investment returns over time. Moreover, if short-term interest rates are very low, it is possible that fees charged by the fund will exceed the income earned on fund investments, in which case fund investors may face losses. As with any investment, you should consider the impact of fees on your investment.
- Money invested in a money market fund, like money invested in any mutual fund, is not guaranteed by the FDIC like bank accounts are. Accordingly, there is a risk you may lose some or all of the money you invested.
What tools can money market funds use in times of market stress?
In times of market stress, many investors may sell their money market fund shares because they are worried that the NAV of their money market fund is going to decrease. That is, they are concerned that stable NAV money market funds might “break the buck” and that the shares would be worth less than $1.00 or that floating NAV money market funds’ NAV might decrease substantially. In both cases, investors are trying to sell their shares before their holdings in the fund lose value or lose even more value. If enough investors sell their shares, it can become a run on the fund.
Liquidity fees. If a run on the fund occurs, investors who sell early in the run may get more money for their shares at the expense of investors who hold their shares and sell later. To address this, some money market funds are sometimes required to charge fees, called liquidity fees, when the fund is experiencing heavy redemptions. These liquidity fees are designed to protect the remaining shareholders in these circumstances and to more fairly allocate costs so that the redeeming shareholders bear the costs of selling their shares.
- All money market funds are permitted to charge a liquidity fee.
- Institutional prime and institutional tax-exempt money market funds are generally required to charge a liquidity fee to redeeming investors when a fund has daily net redemptions greater than 5 percent of net assets. These funds also must charge a liquidity fee to redeeming investors in other circumstances if the fund’s board (or its delegate) determines that a fee is in the best interest of the fund.
- In addition, retail prime and retail tax-exempt money market funds must charge a liquidity fee to redeeming investors if the fund’s board (or its delegate) determines that a fee is in the best interest of the fund.
Permanent suspension of redemptions. In certain circumstances that present a significant risk of a run on the fund and potential harm to shareholders, money market funds are permitted (but not required) to permanently suspend redemptions and liquidate (or close) the money market fund. This tool is meant to help facilitate an orderly liquidation of the fund and sale of its assets.
Stable NAV funds and negative interest rates. While interest rates have never moved into negative territory in the U.S., it is possible that negative interest rates could occur during future periods of economic instability. If interest rates and money market funds’ yields were to become negative, retail money market funds and government money market funds (both retail and institutional) could choose to convert from a stable NAV to a floating NAV. Or these money market funds could choose to reduce the number of shares outstanding to continue to maintain a stable NAV. Before doing either of these things, the funds generally must get board approval and provide disclosure to investors. In either case, the investor’s holding in the fund would lose value.
What is the difference between money market funds and money market depository accounts?
Although the names sound similar, there are important differences between money market funds and money market depository accounts. Money market depository accounts are offered by banks and, up to certain limits, guaranteed by the FDIC. That means the money in that money market depository account is fully protected, but only up to the dollar limits established by law. Money in a money market depository account beyond the amount protected by FDIC insurance is subject to the creditworthiness of the issuing bank.
Money invested in a money market fund, like money invested in any mutual fund, is not guaranteed by the FDIC. And, as with all investments, there is a risk you may lose some or all of the money you invested.
Additional Information
This Investor Bulletin represents the views of the staff of the Office of Investor Education and Advocacy. It is not a rule, regulation, or statement of the Securities and Exchange Commission (“Commission”). The Commission has neither approved nor disapproved its content. This bulletin, like all staff statements, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person.
