09 Apr Endowment Model #8: Money Market Funds
When money is invested in any way, there are three things the investor is looking for in the financial vehicle: growth, safety (risk mitigation), and liquidity. When it comes to stocks, you are sacrificing security for liquidity and excellent potential for growth. With annuities, you exchange liquidity and some growth, for an extended measure of security on your investment. For those looking for liquidity and security, Money Market Funds are a versatile tool for meeting your financial goals.
Picture this; one of your investments you’ve placed your hard-earned money into just isn’t giving you the results that you had hoped for or, even worse, needed. However, this was no nickel and dime operation, it’s a large chunk of your change so you want to make sure you are making the right decision when you reinvest. Which brings us to the next problem, you really haven’t found somewhere that suits your money, or maybe you have, and the timing just isn’t right yet. But your money simply cannot stay where it is right now. Money market funds are a great location for safely storing large amounts of money between investments as they are highly liquid with a very low level of risk.
Money market funds are a kind of mutual fund that invests only highly liquid, near-term instruments, cash equivalent securities and high credit rating debt-based securities with short term maturity. Here is a list of the investments in which money market funds invest in; Bankers Acceptances, Certificates of Deposit, Commercial Paper, Repurchase Agreements, & U.S. Treasuries. Based on the investments these funds are involved in, maturity periods, and other attributes, they are categorized.
1) Prime Money Fund: money market funds that invest primarily in corporate debt securities.
2) Government Money Fund: The Office of Financial Research (OFR) classifies Treasury, Government/Agency, and Tax Exempt Government asset categories as Government funds. In each case, Government funds allocate most of their assets in cash, government securities, and repurchase agreements that are backed by these securities.
3) Treasury Money Fund: money market fund that invests in standard U.S. Treasury issued debt securities such as bills, bonds, and notes.
4) Tax-Exempt money fund: money market fund that offers earnings that are free from U.S. federal income tax. Some may even offer state income tax exemption as well.
The one feature that truly sets money market funds apart from other mutual funds is the NAV standard. Money market funds strive to maintain a net asset value of $1 dollar per share. All the excess earnings on portfolio interest are distributed to investors as dividend payments. This rule allows for regular payments to the investor creating a steady flow of income, as well as making it easy for you to keep track of your net gains. If a money market fund’s NAV ever dropped below $1 there are measures in place to protect the investor even to the point of liquidation of the fund. It is a very rare occurrence as money market funds are considered by most to be close to risk-free. This reputation comes from the types of vehicles they invest in; cash-equivalent securities, and high credit rating debt-based securities with short term maturity (less than 13 months).
Not only are money market funds build for security, but they are also built to be as liquid as possible. You can withdraw your money from these funds at virtually any time. There is simply a limit on the number of withdrawals you can make within a certain time period. And although the securities these funds invest in are only required to have a maturity period of under 13 months, the average maturity of the funds is required to be less than 60 days.
This is called the Weighted Average Maturity period (WAM), and it must be kept at 60 days of less to insure liquidity. Also, these funds managers are not allowed to invest more than 5% in any one issuer, in order to avoid risk with that issuer. The only exceptions would be government-issued securities and repurchase agreements.
Once again money market funds are not meant to be a long-term investment but can be an excellent place to hold your assets while you figure out the best way to allocate them. It is always best to be taking tactical steps towards maximizing your gains while minimizing your risks, and money markets can be a great way to do that.