Are money market funds equity or fixed-income?
A money market fund is a fixed income fund. It holds only short-term, liquid, high quality securities and maintains a lot of liquidity. It's a regulatory designation, there are specific requirements it must meet to call itself “money market” in the US.
Equity markets offer higher expected returns than fixed-income markets, but they also carry higher risk. Equity market investors are typically more interested in capital appreciation and pursue more aggressive strategies than fixed-income market investors.
Many accounts have monthly fees
Another drawback to remember is that while they have high yields, money market accounts can also come with cumbersome fees. Many banks and credit unions will impose monthly fees just for the upkeep of your account.
I suggest a Money Market account with no penalties and full check-writing privileges for your emergency fund. We have a large emergency fund for our household in a mutual-fund company Money Market account.
Money Market Funds
Ultra-conservative investors and unsophisticated investors often stash their cash in money market funds. While these funds provide a high degree of safety, they should only be used for short-term investment. There's no need to avoid equity funds when the economy is slowing.
Income earned from money market fund interest is taxed as regular income, up to 37% depending on the investor's tax bracket. While some local and state taxes offer breaks on income earned from U.S. Treasury bonds, federal income tax still applies.
“That's why fixed income is a great way to allocate capital, because it provides both income and return with stability,” Kyle says. Additionally, investing in fixed income can help balance out market volatility.
Fixed-income provides stability and regular cash flow, while stock investments offer growth over time, albeit at the expense of volatility. So a good investor can design a portfolio with both elements to meet their short- and long-term needs.
Relatively Less Volatile
The steady and stable interest payments from fixed-income products can partly offset losses from the decline in stock prices. As a result, these safe investments help to diversify the risk of an investment portfolio.
Money market accounts tend to pay you higher interest rates than other types of savings accounts. On the other hand, money market accounts usually limit the number of transactions you can make by check, debit card, or electronic transfer.
What are the risks of money market funds?
Because they invest in fixed income securities, money market funds and ultra-short duration funds are subject to three main risks: interest rate risk, liquidity risk and credit risk.
Money market accounts (MMAs) and certificates of deposit (CDs) are types of federally insured savings accounts that earn interest. But their rates and ease of access differ. CDs tend to have higher rates than money market accounts and give no access to your money until a term ends.
There's no risk of you losing your deposit with a money market account. While money market accounts are considered low-risk accounts, that doesn't mean there aren't small risks to be aware of. The biggest risk a money market account poses is that your money may lose value over time to inflation.
Some money market accounts come with minimum account balances to be able to earn the higher rate of interest. Six to 12 months of living expenses are typically recommended for the amount of money that should be kept in cash in these types of accounts for unforeseen emergencies and life events.
Money market accounts and savings accounts are equally safe places for consumers to keep their savings. However, it's important to open accounts at banks that are covered by FDIC insurance. You can check if your bank is FDIC-insured here.
Money market funds seek stability and security with the goal of never losing money and keeping net asset value (NAV) at $1. This one-buck NAV baseline gives rise to the phrase "break the buck," meaning that if the value falls below the $1 NAV level, some of the original investment is gone and investors will lose money.
Money market funds are another option for holding on to cash during a recession. While their yields may eventually fall when interest rates do, they can offer protection for your capital and easy access to your cash when longer-term investment opportunities reappear.
Investors seeking stability in a recession often turn to investment-grade bonds. These are debt securities issued by financially strong corporations or government entities. They offer regular interest payments and a smaller risk of default, relative to bonds with lower ratings.
For a state marginal income tax rate of 6%, and a federal marginal income tax rate of 25%, a taxable money market rate of 5% is equivalent to a 3.53% state tax–free money market rate. If you can do better than 3.53% on the state tax–free money market fund, go with it. If you can only get 3%, stay with the taxable fund.
Two things to bear in mind: First, only the interest you earn is taxable. You are not taxed on your account balance. If you saved $8,000 in a money market last year and earned 4% annual percentage yield (APY), or $320, you would pay income taxes on $320—not $8,000.
Do you pay capital gains taxes on money market funds?
Typically, money market funds pay dividends monthly, and the earnings made in 2023 “could be significant,” said Day. “But unfortunately, this is before taxes.” Rather than more favorable capital gains rates, you'll owe regular income taxes on money market fund earnings, with a top bracket of 37%.
In current market circ*mstances, with higher bond yields, fixed income investments have become an attractive asset class again from a risk-return perspective. Apart from the attractive yield, bonds also offer resilience for adverse market developments in risk assets like equities.
Fixed-income investing can be a good strategy for new investors who want stability and regular income. Bonds and other fixed-income assets offer reliable returns and can help manage risk, as they are less volatile than stocks.
The factors that affect the bond markets and interest rates are very complex. Economics, monetary and fiscal policy, business conditions, international trade, currency movements, and capital flows all affect market interest rates.
Fixed income investing can be a particularly good option if you're living on an actual fixed income and looking for ways to maximize your savings.
