In a previous article, I wrote about the role of cash—an umbrella term used to describe not just hard currency but other safe, liquid assets such as Treasury bills, certificates of deposit, and bank accounts. Here, I’ll talk more specifically about money market funds, which are mutual funds that invest in short-term debt instruments with high credit quality, including US Treasury bills and short-term unsecured corporate-backed notes (aka commercial paper). Money market funds aim to sustain a net asset value of $1.00 per share while offering higher yields than bank savings accounts.
What Are the Advantages and Risks of Using a Money Market Fund?
Money market funds are popular with both individual savers and corporations, who often use them as a tool for managing the cash on their balance sheets. Based on data from Morningstar Direct, assets in US-based money market funds totaled more than $7 trillion as of Jan. 31, 2026—larger than any other category group except for US equity funds.
Money market funds are popular partly because of their convenience. They’re available through any major brokerage platform and often offer features such as check writing, making them easy to use for larger expenses such as tax payments and major purchases. Shareholders in money market funds can easily transfer assets to or from a bank account or a longer-term investment vehicle.
There are several types of money market funds, including:
- Tax-free money market funds, which invest in short-term municipal money market securities that are often exempt from some federal and state taxes.
- Prime money market funds, which mainly invest in commercial paper and other high-quality, short-term obligations other than Treasury bills and other government-issued securities.
- Taxable money market funds, which invest in taxable securities such as Treasury bills, other short-term government obligations, and other high-quality, floating-rate debt such as commercial paper.
In this article, I’ll focus mainly on taxable money market funds, which account for the bulk of money market fund assets. Their holdings typically have pristine credit quality. Treasury bills are supported by the full faith and credit of the US government. Other short-term government debt, such as bills issued by the Federal National Mortgage Association, doesn’t carry an explicit full faith and credit backing, but comes with a fairly solid implicit guarantee as government-sponsored enterprises. Commercial paper is mainly issued by large, financially established companies with solid balance sheets.
Moreover, all three types of holdings have very short maturities (with bonds coming due in weeks or months). As a result, they take on little to no interest rate risk. Because maturities are so short, portfolio yields quickly respond to changes in prevailing interest rates as bills mature and get replaced.
Money market funds are also safe because they generally don’t lose value, at least in nominal terms. (There have been a few exceptions, which I’ll talk about shortly.)
This safety comes at a price: lower returns. Like other forms of cash, money market funds have had both the lowest risk and among the lowest returns compared with other types of assets.
Because cash has no potential for capital appreciation, returns on money market funds are driven by yield. Over the past 40 years or so, income returns for money market funds have ranged from a high of 13.4% in 1981 to a low of 0.01% in 2013 and 2014.
But holding money market funds isn’t usually a good way to stay ahead of inflation, as shown in the table below. Thanks to elevated yields at the short end of the yield curve, the average money market fund has generated returns slightly higher than inflation over the past three years or so. This pattern usually doesn’t happen, though, and returns for these vehicles have lagged inflation over longer periods.
Past Problems With Money Market Funds
Money market funds don’t have a completely unblemished record. In contrast to bank accounts, which are insured by the Federal Deposit Insurance Corporation for up to $250,000 per depositor, per bank, money market funds don’t come with a guarantee.
And on occasion, money market funds have “broken the buck” by dropping below a $1.00 per share net asset value. In 1978, First Multifund for Daily Income took losses on some of its longer-maturity holdings as interest rates spiked and eventually liquidated at $0.94 per share. A similar problem arose in 1994, when Community Bankers U.S. Government Money Market Fund liquidated at $0.96 per share after suffering losses on interest rate derivatives as the Federal Reserve raised rates.
The biggest problems came around the global financial crisis. In 2007, several funds were exposed to defaults on commercial paper linked to subprime mortgages, but their sponsors stepped in to prevent their NAVs from dropping. In 2008, the Reserve Primary fund dropped to $0.97 per share thanks to Lehman Brothers’ default on commercial paper. And in 2020, several prime (institutional) money market funds suffered a liquidity crunch but maintained their $1.00 per share net asset values when the Fed created an emergency lending program to cover losses.
Recent Reforms
In July 2023, the Securities and Exchange Commission adopted a series of reforms meant to reduce the risk of future money market woes. Among other things, the SEC tightened liquidity requirements for money market funds’ portfolio holdings, eliminated automatic redemption “gates” tied to certain liquidity thresholds, imposed a mandatory liquidity fee for certain funds, and set new rules for disclosure and stress-testing.
With these reforms in place, Paul Olmsted, a Morningstar principal for fixed-income strategies, considers most money market funds a relatively safe bet.
The table below highlights some of the most popular money market funds that are widely available to individual investors.
How Long Should I Plan to Hold a Money Market Fund?
Morningstar’s Role in Portfolio Framework considers money market funds a suitable asset for relatively short holding periods (less than one to two years). If you have a spending need coming up a bit further out, such as within three or four years, a money market fund could also be a reasonable parking spot, depending on where yields currently stand relative to inflation.
How Much of My Portfolio Should Be in a Money Market Fund?
You don’t necessarily need to own a money market fund. As mentioned above, they can be a convenient option for savings and cash management. Personally, I’ve always held some assets in a money market fund mainly because of the convenience factor.
If you do use a money market fund for cash management, the size of that position largely depends on your life stage. If you’re many years away from retirement, you don’t need to allocate much to cash, assuming you already have an emergency fund set aside, as well as enough liquid assets to cover any short-term spending needs.
Setting aside some assets in a money market fund or other cashlike assets gets more important as you get closer to retirement age. Financial advisors typically recommend that retirees keep at least one to two years’ worth of expenses in cash or other low-risk assets. Holding cash gives you a ready source of liquidity for short-term spending and means you don’t have to sell stocks or bonds when the market is down.