Money Market Fund

A money market fund is an SEC-registered investment company, a type of mutual fund, that invests in short-term debt instruments and aims to hold its share price steady while paying out its income. It is a security rather than a deposit, which means it carries no federal deposit insurance and its value can fall. The SEC's own investor material puts it plainly: money invested in a money market fund is not guaranteed by the FDIC like bank accounts are, and there is therefore a risk you may lose some or all of the money you invested.

That has to come first because of the name. A money market account is a bank deposit, classified in federal banking regulation as a form of savings deposit, and the FDIC lists money market deposit accounts among the products it insures. A money market fund is a fund. One word separates them, they are commonly offered by the same institution, they frequently appear side by side on the same screen, and only one of the two cannot lose value. The published material on money market accounts covers the deposit side of the pair.

The specific rules a money market fund lives under are in SEC Rule 2a-7, at 17 CFR 270.2a-7, which constrains what the fund may hold, how liquid it must be, and in some cases how it must price its shares. Those constraints are why a money market fund behaves much more like cash than a bond fund does, and they are not a guarantee.

Rule 2a-7 defines two kinds of money market fund and treats the rest as a residual, which is a more precise picture than the usual list of four. A government money market fund "means a money market fund that invests 99.5 percent or more of its total assets in cash, government securities, and/or repurchase agreements that are collateralized fully." A retail money market fund "means a money market fund that has policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons." Note what that second definition turns on: who may own the shares, not a minimum investment. Every other fund is described in the rule only negatively, as "a money market fund that is not a government money market fund or a retail money market fund," and the market calls those institutional prime and institutional municipal funds. The words "prime" and "municipal" are not defined categories in the rule at all; what it does define separately is a tax exempt fund, meaning one that "holds itself out as distributing income exempt from regular federal income tax."

The stable-versus-floating share price is drawn on that line, and the popular version of it is wrong. Under 2a-7(c)(1)(i) a government or retail fund may compute its price per share using the amortized cost method or penny rounding, in order to maintain a stable net asset value, provided the board determines in good faith that doing so is in shareholders' interests and that the method fairly reflects the market-based value. Under (c)(1)(ii) any fund that is not government or retail "must compute its price per share ... by rounding the fund's current net asset value per share to a minimum of the fourth decimal place in the case of a fund with a $1.0000 share price." So a retail prime fund holds a stable price, and the sentence "prime funds float" describes only the institutional ones. Since retail funds are defined by being limited to natural persons, an ordinary individual investor's prime fund is normally a stable-price fund.

The two liquidity fees are separate instruments and merging them misdescribes both. The discretionary fee at 2a-7(c)(2)(i) applies where "the fund's board of directors, including a majority of the directors who are not interested persons of the fund, determines that a liquidity fee is in the best interests of the fund," in which case the fund must impose one "not to exceed two percent of the value of the shares redeemed." Once imposed it applies to all shares redeemed and stays until the board decides otherwise, and it does not apply to a government fund, which may nevertheless choose to rely on it. The mandatory fee at (c)(2)(ii) is automatic and narrower: if a fund that is not a government fund and not a retail fund "has total daily net redemptions that exceed five percent of the fund's net assets," or a smaller figure the board sets, it must apply a fee to all shares redeemed at a price computed that day. The amount is a good-faith, data-supported estimate of the cost of selling a pro rata slice of the portfolio, including spread costs and market impact; where that cannot be estimated in good faith the fee "is one percent of the value of shares redeemed"; and no fee need be applied where the computed amount is below 0.01 percent of the shares redeemed. An individual holding a retail or government fund is therefore never subject to the mandatory fee.

Redemption gates are no longer in Rule 2a-7, and the rule changed recently enough that a reader may well have been told otherwise. The 2014 amendments had allowed a fund's board to suspend redemptions temporarily, and the 2023 amendments removed that mechanism and substituted the fees above. There is no gate provision in the current text of the rule. What survives is different and narrower: Rule 22e-3, at 17 CFR 270.22e-3, exempts a money market fund from the general prohibition on suspending redemptions where three conditions are met together, and the second is decisive. The fund must have fallen below the specified liquidity or price threshold; its board, including a majority of independent directors, must have "irrevocably ... approved the liquidation of the fund"; and it must notify the SEC before suspending. So a fund can stop honoring redemptions only on its way out of existence, and that route does reach government and retail funds as well. A suspension is an incident of liquidation rather than a tool for managing a bad week.

Breaking the buck has a regulatory tripwire, which is more precise than the folklore. Under 2a-7(g)(1) a fund using amortized cost must calculate the deviation between that price and a market-based valuation at least daily, and "in the event such deviation from the money market fund's amortized cost price per share exceeds 1/2 of 1 percent, the board of directors shall promptly consider what action, if any, should be initiated." Note what the provision requires, which is consideration rather than a particular outcome, and note what it measures, which is the gap between the reported stable price and the portfolio's market value. On a $1.0000 share that threshold is a market-based value below $0.9950.

What protects the money, since deposit insurance does not. Shares held in a brokerage account fall within the Securities Investor Protection Act, which is custody protection rather than value protection. 15 USC 78fff-3(a) caps an advance used to fill the shortfall after customer property has been distributed at $500,000, with $250,000 of that for cash. A money market fund is a security, so it sits under the securities figure rather than the cash one. SIPC also covers no market loss: a fund whose share price falls is not a SIPC claim, it is an investment outcome. The published material on broker-dealers covers what the protection does and does not reach.

You buy shares through a brokerage or fund company. The fund invests in short-term instruments within the constraints Rule 2a-7 sets, earns income, and distributes it, typically daily accrual paid monthly. If the fund is a government or retail fund it will normally report a share price of $1.00 and your account value will simply be the number of shares. If it is neither, the price is computed to four decimal places and moves.

A hypothetical example of what four-decimal pricing makes visible. An institutional prime fund's portfolio falls slightly in value and its price per share is computed at $0.9985. A holder of 1,000,000 shares therefore has $998,500 rather than $1,000,000, and the $1,500 difference is on the statement because the rule requires the price to be rounded to at least the fourth decimal place. A government or retail fund holding a similar portfolio would report $1.00 a share, so the same movement would be invisible until it was large enough to matter. That is the trade the two pricing regimes make.

On the same fund, the tripwire sits at $0.9950, since a deviation of more than one half of one percent from a $1.0000 amortized cost price obliges the board to consider promptly what action, if any, to take.

A second hypothetical, on the mandatory liquidity fee. Investors redeem enough from an institutional prime fund in one day that net redemptions exceed 5% of its net assets, and the fund cannot estimate its liquidation costs in a way supported by data, so the rule's default applies. A redemption of $500,000 that day therefore carries a fee of 1%, or $5,000, and the investor receives $495,000. Had the board instead imposed a discretionary fee at the 2% ceiling, the same redemption would have cost $10,000.

Neither fee is a penalty for doing something wrong. Both exist so that the cost of turning portfolio securities into cash falls on the investors who caused it rather than on those who stayed, and a retail or government fund holder is not subject to the mandatory one at all.

Pros

• Yields respond quickly to short-term interest rates, because the portfolio turns over constantly.
• Rule 2a-7 constrains credit quality, maturity and liquidity, so the range of outcomes is far narrower than for a bond fund.
• Government and retail funds may hold a stable share price, so a statement usually reads like a cash balance.
• Shares are generally redeemable on the same or the next business day, which suits money waiting for a purpose.
• A tax exempt fund distributes income exempt from regular federal income tax, which can suit a high-bracket investor.

Cons

• It is not FDIC-insured and it can lose value. That is the single most important difference from the similarly named bank account.
• An institutional prime or municipal fund must price to four decimals, so its value visibly moves.
• A non-government fund's board may impose a fee of up to 2% on redemptions, and an institutional prime or municipal fund must impose one when daily net redemptions exceed 5% of net assets.
• A fund heading into liquidation may suspend redemptions altogether under Rule 22e-3, which reaches government and retail funds too.
• It has an expense ratio, so a stated yield is what remains after the manager is paid, and in a low-rate period fees can consume most of the return.
• Income is generally taxed as ordinary income in the year received unless the fund is a tax exempt fund.