In my recent article about how to start an IRA with $1 in 15 minutes, I said that you would be putting your money into a money market fund. I thought I should explain in more detail what this is for those of you who decided to go this route, so that you are informed about and comfortable with where your money is. And for those of you who may have shied away from opening your IRA because you didn’t know what a money market fund was, let this be your last excuse!
A money market fund is a type of mutual fund that is legally required to invest in low-risk securities including government securities, certificates of deposit, commercial paper of companies, and other highly liquid and low-risk securities. It is similar to a high interest savings account in that it returns about the same amount of interest and is considered to be just as safe and stable.
A money market fund should not be confused with a money market account at a bank. While a money market account at a bank (or any other type of account at a bank) is covered by federal deposit insurance (up to $100,000), the money you put in a money market fund is not insured. Despite what you might initially think, though, that doesn’t really mean it’s less safe. It is technically possible to lose money in a money market fund, but it is rare. Jonathan of My Money Blog recently did the research on this subject, and he learned that the Investment Company Act of 1940 protects the money you invest through brokerage firms such as Vanguard or Fidelity.
Barring some sort of major disaster that none of us could adequately prepare for, your money is actually more at risk if you don’t save it and don’t invest it. Inflation and taxes whittle away the value of your money over time, so it’s important to invest in tax advantaged accounts (like IRA’s and 401k’s) and earn an interest rate that, at a bare minimum, keeps up with inflation (historically, about 3% a year).
To learn more about money market funds straight from the horse’s mouth, check out this page on Fidelity Cash Reserves.