Why can money market funds make sense when rates are rising?

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Amid rising interest rates, investors may be wondering where to put their money. Enter money market funds.

While higher interest rates are generally viewed negatively as a “drag on the economy, a burden for people seeking mortgages and a punishing hurdle for stocks,” said The New York Times, they are also an “unambiguous boon in one unheralded area: money market funds.” For this specific type of mutual fund, “higher rates almost immediately funnel more money to investors without major complications.” Here is what to know about them.

What are money market funds?

This type of mutual fund invests in “highly liquid, near-term instruments” such as “cash, cash equivalent securities and high-credit-rating, debt-based securities with a short-term maturity, such as United States Treasuries,” said Investopedia. Like other types of mutual funds, money market funds pool money from numerous investors to buy into these investments, which then earn interest that the fund pays out to investors as dividends.

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Money market funds have a “fixed price of $1 per share,” and they “aim to maintain their net asset value (NAV),” which “means your account value shouldn’t change other than any growth from your earnings,” said Vanguard. Their yields can vary, however.

When can money market funds make sense to invest in?

The goal of investing in a money market fund is generally to “keep your money’s value stable, easy to access and earning a competitive interest rate until you need it,” said Schwab. Money market funds tend to generate higher income than you would typically earn with a bank account.

At the same time, they are “less prone to market fluctuations than many other types of investments,” said Fidelity. They are also “subject to less interest rate risk than longer-maturing bond fund investments” due to their focus on near-term instruments. This translates to providing some level of safety and stability.

Money market funds are potentially most advantageous in a rising-rate environment. “When rates are rising, income from money market funds will typically rise as well,” said Vanguard.

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Are there risks to money market funds?

You will also want to be aware that the “income generated by money market funds typically won’t protect you against the loss of purchasing power over time due to inflation,” said Schwab. While the returns from a money market fund are likely “better than the nearly nothing you would receive in a standard checking account,” they are “so small, they are barely visible” when compared to investments like stocks, said the Times. Still, the stability and small wins they offer when rates are rising can make them worthwhile.