UNDERSTANDING MONEY MARKET FUNDS

Money market funds can play an important role in a well-structured investment portfolio. Here is a brief guide to help you understand what a money market fund is and what it can offer your portfolio.

The Money Market
In order to understand what a money market fund is, it's important to understand the concept of the money market.

Organizations such as banks, businesses and government agencies frequently find that short-term financing—in other words, borrowing—can be an effective money management tool. The money market provides a place where they can borrow funds for as little as one night or as long as 360 days. A large company, for example, might use the money market as a convenient place to borrow money short-term if its cash disbursements temporarily exceed its cash inflow.

Unlike securities exchanges, the money market has no specific location. It is primarily a telephone market and is easily accessible from all parts of the country as well as from foreign financial centers.

What is a Money Market Fund?
Money market funds are mutual funds that invest in debt securities within the money market. By purchasing money market instruments, the fund manager is using the fund’s assets to make short-term loans to corporate and government “borrowers.”

The Securities and Exchange Commission requires that money market funds restrict their portfolios to high-quality securities that are easily bought and sold and have average maturities of 90 days or less. As a result: money market funds are generally stable, readily liquid investments that provide investors the ability to buy and redeem shares at a constant price. It should be noted, however, that money market funds are not insured or guaranteed by the U.S. government and there is no assurance that any fund will maintain a stable $1 a share net asset value.

Benefits
A money market fund offers you the flexibility of adding to your account whenever you want, and withdrawing funds whenever you need to. Because of the liquidity and safety money market funds offer, many investors use them as a short-term depository for money that they expect to use soon—for either a purchase or an investment—or as vehicles for the cash "cushion" they keep for possible emergencies.
Because many mutual fund families allow investors to transfer money between funds, you might want to consider using a money market fund as part of an investment strategy called dollar-cost averaging. It works like this: Transfer the assets in your money market fund into another mutual fund within the same mutual family in a series of regular installments—regardless of the current price of the fund's shares. It is important, however, that you be in a position to be able to continue with your investment program even if the economy goes into a decline. While dollar-cost averaging does not guarantee that you will never lose money in the stock market, it will enable you to reduce the risk of buying at a time when the cost of shares is high. Instead, you will buy fewer shares in the months when their cost is up, and more when prices drop.

Pros and Cons
Every investment has its risks and opportunities. An aggressive stock fund may offer a high rate of return, but the potential for gain is counterbalanced by a proportionally high level of investment risk.
Money market funds carry very little investment risk, but they are not the place to invest your assets if you're seeking the highest possible yields. In fact, their earnings rate might not even keep pace with the rate of inflation, meaning that the “buying power” of your money market assets may actually decline over time.

What money market funds do offer is relatively safe and highly liquid investment that can help you diversify a portfolio that is otherwise aimed at maximizing returns.