As we transition from savers to investors, so should our mindset about the types of accounts we hold. High-yield savings accounts and certificates of deposits are great for building emergency funds and saving for house down payments.
However, these accounts are a few steps removed from the stock market. If we want to become major players in the investment world, we must use accounts that exist in that world.
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How investors think. Investors think about the financial cost of something as well as the opportunity costs.
Usually, it takes a couple of days to transfer money from a savings or checking account to a brokerage account on the stock market.
24-48 hours is a very long time in the stock market. For example, yesterday (Feb 2, 2024), Facebook (META) increased its value by 20% off a good earnings call.
As investors, we must keep our money close to the stock market. We don’t have time to transition money between Main Street (checkings) and Wall Street (brokerage). This is where Money Market Funds can help us expand our investing prowess.
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What is a Money Market Fund? A money market fund (MMF) is a mutual fund that trades on the stock market. For reference, mutual funds trade after the stock market closes for the day.
The goal of a money market fund is to keep its net asset value at $1 per share. The government heavily regulates what MMFs can invest to keep their value consistent.
MMFs invest in treasury bills, short-term commercial paper, and certificates of deposit. There is also a tax-exempt variant that invests in municipal bonds.
As the MMF keeps its net asset value at $1, it has to pay its expenses and interest to its inventors. Therefore, it’s crucial that they remain aggressive but also stay within the regulations that the Security and Exchange Commission (SEC) deems appropriate.
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A lot is going on behind the scenes that you should dig into as you look into investing in MMFs. But, the most critical decision point is understanding WHY you need a money market fund.
Why use a money market fund? I think of money market funds as a checking account inside your brokerage account.
It’s also important to mention that the Federal Deposit Insurance Company (FDIC) does not protect money market funds—you are out of luck if your MMF goes under.
So why use an MMF if the FDIC does not insure it? I just recently used a money market fund in my options trading brokerage.
I made $4,000 in one day and needed a place to keep it while earning a decent yield. I didn’t want to transfer it from my brokerage into high-yield savings.
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I looked into stocks that would safely hold their value, but most had risks to the principal. I saw an ETF that offered a consistent price but cost an extra $5 per share to purchase (a losing proposition).
After some research, the best place to store my $4,000 was a Charles Schwab money market fund (SWTXX).
Benefits of a money market fund. A money market fund pays you a decent yield, if perhaps a little lower than high-yield savings, certificates of deposit, and treasury bills.
These other accounts try to entice savers and investors to save and invest their money. MMFs know your money is already in the stock market.
MMFs keep your capital close to the action. Remember, MMFs and all mutual funds trade after hours, so you’ll need to plan if you need your money first thing in the morning.
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An excellent way to counteract this situation is to use leverage. Let’s say it is 10:00 am, and I need $2,000 to invest. I can borrow the $2,000 against my money market fund and repay the loan after hours.
Leverage is also a great reason to invest in money market funds versus other savings instruments. Let’s say you have $5,000 in a high-yield savings account.
You need to borrow $1,000 to purchase some tires. You hope to pay back the money to your HYSA over the successive few pay periods.
There is no way to take out a loan against your HYSA. You would need to apply for a loan through your bank. They would use your credit score as their guidepost, not the amount in your HYSA.
Conversely, you could use leverage (called margin) against the $5,000 in your MMF. Usually, your brokerage allows you to borrow 40% to 50% against your total assets.
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In this case, you could have $1,000 in your checking account in less than two minutes. Some people don’t like debt, leverage, or margin, and others want to wield it in their favor.
I personally like to use debt because I hate owing people money. This forces me to pay back my loans as soon as possible. If I use my HYSA funds, there is no real pressure to return the money. Again, that is just the way I view things.
Getting started with money market funds? If you are not a stock market investor, there is no reason to get a money market fund.
If you have a brokerage with a major financial institution like Charles Schwab, T. Rowe Price, or Fidelity, look into the money market funds they offer.
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I have a Charles Schwab, so I use a Charles Schwab Money Market fund (SWTXX) because I will most likely get a better rate.
Be careful not to confuse a money market fund (brokerage) with a money market account (bank). Money market accounts (not FDIC insured) were the high-yielding accounts before high-yielding savings accounts became the new rage.
You can purchase a money market fund once you invest in the stock market. Remember, if you go to buy during open stock market hours, your purchase will sit idle until after hours.
Conclusion. The goal of a money market fund is to act as a holding pin for your investment funds. There are better places to invest if you want to keep this money invested for 2-5 years.
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Money market funds serve an essential role in your saving and investing strategy. You can use them as an emergency backup if you don’t mind using leverage.
If I needed to borrow $1,000, I could quickly borrow against my MMF. Instead of paying 20% interest on a credit card, you can pay more like 7-8%.
I am a long-term, buy-and-hold, dividend investor by nature, so I never needed a money market fund in my first four years of investing.
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However, once I started trading options, I found myself with cash that I wanted to keep close to the stock market. That’s when I discovered the magic of money market funds.
The magic of a money market fund is that it gives you multiple options across saving, investing, and borrowing. You can use the account for many scenarios and tailor it to your needs.
For emergency funds, you have high-yield savings and certificates of deposit. For short-term investments, you have treasuries and bond funds. For long-term investments, you have dividend stocks and index funds.
However, between all these different approaches and scenarios, money market funds help you transition money around your portfolio.
The key is ensuring that you have a purpose for each of these accounts and understand why they are essential to your long-term financial success. Good Luck!
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