Money market mutual funds: why do they exist?

I'm not sure this is the best forum to ask my question and I'm going to sound like an idiot, but here's my question anyway:

Everytime I go to bankrate or some such site and check yields on savings/MMAs/MMMF accounts, I find that the money market mutual funds never offer yields even remotely as good as several high-yield savings/MMAs do. Considering that they are not even FDIC insured, and are actually investments with non-zero risk (as compared to savings accounts), why does anyone put their money into them?

Surely, I am missing something. Anyone care to explain? Thanks.

I just for kicks looked at T. Rowe Price Prime Reserve and found that it has been yielding 0% since 6/1/09. No distributions since the last one on 5/31/09 - a whopping 0.00001% per share. Your question is a good one. I don't know? I thought I was getting jammed at 0.75%!

Frankly, I keep most of my cash/cash equivalent $ in a short term tax-free muni fund which is paying ~ 2.85% (3.8% taxable equiv for my federal bracket).

A Money Market Fund is a type of mutual fund that tends to be riskier than a money market account. Many money market funds invest in short-term securities such as U.S. Treasury bills, certificates of deposits and other investments backed by the U.S. government. Other funds include corporate money funds, which invest in short-term corporate debt and tax-free money funds, which invest in short-term securities issued by municipalities. A Money Market Fund:

* Is not FDIC-insured. The U.S. Treasury has temporarily insured money market funds until April 2009 for holdings held for a year as of September 19, 2008.
* High minimum deposit and minimum balance to avoid high fees.
* A liquid investment that allows for easy withdrawals and check writing
* Has historically provided better yields than money market accounts
* Generally has higher fees than a money market account.
* Maintains the net asset value (NAV) of each share at $1; you put $2 in, you get $2 out.

Thanks for the information blixet and Alex. I am quite aware of most of the items you mentioned (Alex). All of this leads one to a single conclusion: the MMMF should yield more than a savings/MMA (the former being a risky or riskier investment, and the latter being risk-free). This is the nature of things, and is indeed quite obvious.

However, over the past year or more, I have never found the rates (as seen on bankrate.com) to reflect this. The yields are very much the reverse. I don't know if things have been different over a larger time frame (historically), as I had never looked at it earlier. If there is some discrepancy in the market right now because of the crisis and so on, and this is a temporary phenomenon, then that might explain it. Otherwise, I dunno...

Maybe it's just that whenever I check, the 7-day effective yield on the MMMFs are terrible. It is possible that at other times they are far better, as they vary over time.

Jabberwocky,

The reason the MM funds are paying less is because with management comes expenses. The expenses alone do not create the low interest rate, as in better times they usually do pay more than traditional and guaranteed savings.

The main reason for the current ANOMOLY is that a fund has to be pegged at $1 increments. The "share price" is always $1 even though the underlying investments can (and do) fail. To offset these failures AND maintain the $1 share price, the funds must use the interest income of the underlying investments to subsidize the $1 hard pricing of the share which is designed to provide stability to the investor. In short, if the prevailing rate is 3% and the fund loses 2% of it's assets to default, it has to skim that 2% to keep the share price at $1. This leaves 1% of interest credited to the principle.

For comparison, a Money Market DEPOSIT account is pegged to an ongoing interest rate being offered by the bank and is more like a CD except more liquid. They are usually tied to a specific interest-producing asset of the bank. Thus, there is no fluctuation in your dollar because it is not a share...it is a dollar earning interest.

Again, on the MM fund side, the fund can hold bonds as well as cash instruments. If a strip of commercial paper or bond goes bad, then the ZERO value of that commercial paper has to be made up (replaced) to maintain the $1 share price. This is done by skimming the interest rate and adding it to the principle to protect the $1 value.

In a "normal" environment, the MM fund is able to purchase and liquidate instruments at very CURRENT ongoing rates (if the rates climb) and still hold onto the higher interest-producing assets from prior periods. Thus, they are always selling the low paying assets and buying the higher rate assets which typically average out higher than deposit accounts and CDs because you are freed from holding periods. Being stuck with holding periods can lead to interest-rate risk".

Another way to view interest rate risk is being stuck in a low interest paying item because there is a defined holding period. In real time, this is when someone purchases a 5 year CD at 2% only to see CD rates rise to 5% shortly afterward.

As I mentioned earlier, the deposit account will likely be tied to a specific instrument, and that may be that 5 year CD. The MM fund would just dump it and by a higher paying device.

The summary answer is that MM funds are being forced to shore up losses (defaults of holdings) right now to maintain their $1 per share peg.

Your explanation is a good one, thank you. I have a better idea of how this works now. Even so, my question remains why investors aren't pulling their money out of thes MMMFs given that they are underperforming risk-free assets right now (and have been for a while)? I guess, that must be because of the expectation that in the longer term, they will outperform those other instruments. In other words, we may chalk this down simply to some sort of volatility linked to poor economic conditions of the present (such as non-performing debt). Would that be right?

I think the primary reason would be that a surprisingly high percentage of individual investors are actually NOT proactive in monitoring their finances or seeking higher returns with safe money.

It is likely that many view their MM funds as a safe place for their money and would rather just sit it out instead of actually "moving" money in this environment. In short, they are hunkered down. Or, they simply are not aware of the low rate being paid and the fact that other, safer investments may actually be paying more.