Long Term Planning

Money market mutual funds

Many times, a money market mutual fund is used fro an emergency fund, for short term savings, or for other expenses that you plan to save fro and need to pay within 3 years. This may be your first step into investment beyond the realm of banks. Money market mutual funds are not FDIC insured. There is a very small possibility that you could lose your principle in these accounts. Thus is where you start to develop you risk tolerance.

Selecting a money market mutual fund from a major mutual fund company such as Fidelity, Strong, Vanguard, T. Rowe Price or others means you have very little practical risk that you will lose any of your principle. The embarrassment to the company due to a loss in a money market account would be devastating to business. The company would most likely forgo profits in other areas to subsidize its money market fund. So, while there is risk here, this little risk.

Worth mentioning: In all of the years that these funds have been around, only one did not pay the full amount of principal to its shareholders. The money market fund in question was from a very small mutual fund company located in Colorado – and it paid pretty close to 90 cents on the dollar.

How they work

Basically, a money market mutual fund is an investment pool, which is why it is called a mutual fund in the first place. The mutual fund hires a fund manager, which might be an individual or even a company, to make the daily investment decisions regarding it. This fund manager has training and experience in investments.

Money market mutual fund shares are always worth one dollar. Any income to the fund is paid monthly in the form of a dividend. You can think about these dividends as something like interest paid from bank accounts. Dividends are divided among accounts in proportion to their balances. Every account earns the same dividend rate.

When you open a money market mutual fund, you buy shares in that fund. If you invest $2,000 you get 2,000 shares. The fund pools the contributions of it’s shareholders to make investments. The fund manager of a money market mutual fund invests only in bonds (debts of companies and government units) that will mature in an average of less than 90 days. Since the money market mutual fund buys bonds whose maturity is extremely short, the fund manager will most likely understand if there is any reason the bond will not be paid in full and on time.

Quality of funds

There are many different kinds of money market mutual funds, depending on the types of bonds they invest in. A fund called just a money market fund will most likely invest largely in corporate bond, with some government bonds in the mix. These do not pay the highest interest but they make up for that in the fact that they are almost risk free.

Bonds rated BB, B, CC, or lower are known as junk bonds or high yield bonds. These often pay higher rates of interest because there is a greater risk that all of the interest payments will not be paid on time and there is a risk that you may not ever get your principal back. Bonds rated D are actually in default and the promises made by the corporation have not been fulfilled.

Keep in mind: Never get tempted by the high interest rates on very risky investments. They have to pay higher interest or nobody would but them at all right? As a new investor, it is vital that you understand (especially if you just became debt free from a bad credit/debt history) that high risk investments are not the way to go for you right now – if ever.

(642)

Back to News Updates