Money Market funds

An investor's need for liquidity determines how much to place in money market mutual funds. There are both taxable and tax-exempt money market mutual funds. The tax-exempt money market funds buy short-term obligations of states, counties, cities, school districts, etc. They pay low rates of interest, but since it's tax-free, investors in high marginal tax brackets come out ahead.

The benefit of the money market mutual fund is its stable value. The money investors put here can be turned right back into the same amount of money without worrying, unlike the money in a bond or stock fund. Investors earn low returns but can often write checks against these accounts, which are treated like a sale of so-many shares times $1 each.

Another use for these funds is as a vehicle in which to sweep a brokerage customer's cash after a deposit, dividend, interest payment, or sale occurs. Money market mutual funds are a holding place for cash that is not ready to be either invested long-term or spent by the customer.

As the SEC explains, "Money market funds pay dividends that reflect prevailing short-term interest rates, are redeemable on demand, and, unlike other investment companies, seek to maintain a stable NAV, typically $1.00. This combination of principal stability, liquidity, and payment of short-term yields has made money market funds popular cash management vehicles for both retail and institutional investors."

Some of these funds keep at least 99.5% of their portfolio in Treasury securities and are called government money market funds. The funds that hold municipal securities are tax-exempt money market funds. Those holding corporate debt securities are known as prime money market funds. These three types can be for retail or institutional investors.

Because of the financial crisis of 2008, the SEC wants to prevent future runs on money market funds during extraordinary situations. The problem is if funds artificially maintain a NAV of $1 when their portfolio may suddenly not be worth that amount, there is a first-mover advantage for investors to hurry up and pull out. To prevent this the SEC now requires institutional prime and tax-exempt money market mutual funds to value their NAV at the actual market value of the securities called floating the NAV. This way, there is a natural disincentive to run for the exits and end up receiving only, say, 97 cents on the dollar.
Also, except for government money market funds, both retail and institutional prime and tax-exempt funds can impose both liquidity fees of up to 2% to discourage redemptions and even a temporary halt to redemptions if the situation is dire.

If the board of directors for the fund decides the redemption gate is in the best interest of the shareholders, they can impose it for up to 10 business days. No more than one 10-day gate or halt could be imposed, however, in any 90-day period.

As with all funds, investors pay operating expenses in exchange for the benefits provided by the investment product. Money market funds do not charge sales charges but typically impose a 12 b-1 fee of .25% as well as management fees and transfer agent fees, etc.

So, while money market mutual funds are a safe and liquid investment, their liquidity is not as automatic and across the board as it once was, especially outside of govern¬ment money market funds.