What is a Money Market Fund?

A Money Market Fund (MMF) is a type of mutual fund that invests in money market instruments or short-term fixed income instruments. For example, the underlying investments can include cash, high quality government bonds, short-dated corporate bonds and commercial paper.

Among the well-known key advantages of MMFs are high (credit) quality, good liquidity (i.e. easy access to funds), good diversification and higher income potential compared to regular bank savings accounts.

High quality benefit

MMFs invest in only the highest credit quality issuers and instruments. This means that any of the issuing entities whose securities the fund is invested in should have a very low risk of not meeting their payment obligations.

Another advantage of high credit quality and the short-term nature of MMF holdings is that they tend to be far less impacted by periods of increased financial market volatility.

High liquidity benefit

Due to the quality and short-term nature of their investments, MMFs are considered to be highly liquid. This means that there is no lock-up period and investors can withdraw at any time and without any penalty for doing so.

Enhanced diversification

Compared to leaving cash balances with a small number of financial institutions, diversification is likely to be considerably enhanced in a MMF. This is because MMFs will have many more underlying holdings with distinct issuing entities, including various governments and companies.

Income advantage over bank savings accounts

A key advantage of MMFs is that they typically offer higher interest rates than those available from bank savings accounts. Following an extended period of generally very low interest rates, since 2022 global interest rates have normalised to higher levels*, which has boosted the appeal of MMFs.

*Source: Board of Governors of the Federal Reserve System (US) via FRED®, Jan 2025

Potential scope for capital gains

Unlike bank savings accounts, it’s worth noting that MMFs usually do have a small degree of duration. This means that modest price changes will typically result from interest changes. In particular, in periods of declining interest rates, the duration impact would be to enhance returns, while the converse would be true whenever interest rates are rising.

Since MMFs are usually actively managed, fund managers have some scope to potentially boost total returns by adjusting duration. For example, in rate-cutting environments, duration exposure may selectively be dialled up in order to benefit more from expected price rises.

Comparing with other asset classes

While MMFs have benefited from increased yield levels since 2022, it is worth noting that they do not have the kind of long-term growth potential of many other asset, including equities or bonds. The reason for this is that unlike other assets, MMFs are considered very low risk and stable investments that should be less susceptible to market volatility.

Final thoughts

MMFs are low risk investments that combine the benefits of high quality, good liquidity, good diversification and higher income potential compared to regular bank savings accounts.

While they may not offer the long-term growth potential of some other asset classes such as equities and bonds, this is because they are in an altogether much lower risk category. And a key benefit of this is relative stability and resilience in periods of increased market volatility.