What Is a Money Market Fund? NAV, SEC Rules, Prime vs. Government Funds

What Is a Money Market Fund?

A money market fund is a type of mutual fund that invests in short-term, high-quality debt instruments—such as Treasury bills, commercial paper, repurchase agreements (repos), and certificates of deposit—with the goal of maintaining a stable net asset value (NAV) of $1.00 per share while providing liquidity and modest income. Unlike money market accounts at banks, money market funds are investment products and are not FDIC-insured. They are regulated by the Securities and Exchange Commission (SEC) under Rule 2a-7 of the Investment Company Act of 1940.

Money market funds serve as a parking place for cash—a higher-yielding alternative to letting money sit idle in a checking account. They are widely used by individual investors, corporations managing operating cash, and institutional investors holding liquidity reserves. Total assets in US money market funds regularly exceed $6 trillion, making them systemically important financial instruments.

How They Differ From Money Market Accounts

The naming similarity between money market funds and money market accounts causes significant confusion. The key differences:

• Insurance: Money market accounts at banks are FDIC-insured up to $250,000. Money market funds have no government insurance—though they aim for stable value.
• Regulation: Money market accounts are banking products regulated by bank regulators. Money market funds are investment products regulated by the SEC.
• Where purchased: Money market accounts are opened at banks or credit unions. Money market funds are purchased through brokerages, mutual fund companies, or retirement accounts.
• Yield: Both yield similarly and move with prevailing short-term interest rates. Institutional money market funds sometimes edge out money market account rates; the gap varies by rate environment.
• Risk of breaking the dollar: In extremely rare circumstances, a money market fund can fall below $1 NAV—known as "breaking the buck." This occurred in 2008 with the Reserve Primary Fund. No FDIC backstop exists, though government intervention has prevented broader systemic loss.

The $1 NAV and Breaking the Buck

The defining feature of traditional (stable value) money market funds is the $1.00 NAV. Every share is designed to be worth exactly one dollar. This stability is achieved by investing only in short-term, high-quality instruments, keeping weighted average maturity (WAM) short (maximum 60 days under Rule 2a-7), and using amortized cost accounting.

In the 2008 financial crisis, the Reserve Primary Fund held Lehman Brothers commercial paper. When Lehman declared bankruptcy, the fund's NAV fell to $0.97—it broke the buck. This triggered a broader panic and run on money market funds industry-wide, forcing the Treasury Department to guarantee money market funds temporarily and the Fed to purchase commercial paper directly. The incident led to significant reforms in money market fund regulation, including mandatory liquidity requirements and new provisions for imposing fees or gates during stress periods.

SEC Rule 2a-7 and Regulations

SEC Rule 2a-7 governs money market fund operations with strict requirements:

• Credit quality: Funds can only hold securities rated in the top two credit tiers. Prime funds can hold commercial paper and other corporate instruments. Government funds can only hold government and agency securities.
• Maturity limits: Weighted average maturity must be 60 days or less. Weighted average life must be 120 days or less. No individual security can have a remaining maturity over 397 days.
• Liquidity requirements: Minimum daily liquid assets (securities maturing within one business day) of at least 10%; minimum weekly liquid assets of at least 30%.
• Stress testing: Fund managers must conduct regular stress tests to assess fund resilience under adverse conditions.

Post-2016 reforms added floating NAV requirements for institutional prime funds (they must disclose their true NAV, which may fluctuate near $1 rather than maintaining a fixed $1), while retail prime funds and all government funds retained the stable $1 NAV.

Prime vs. Government Money Market Funds

The two major categories of money market funds serve different risk/return profiles:

• Government money market funds: Invest exclusively in US government securities (Treasury bills, agency bonds) and repos collateralized by government securities. They retained the stable $1 NAV post-2016 reforms and are exempt from the liquidity fee and redemption gate provisions that apply to prime funds. Considered the safest money market fund category. Slightly lower yields than prime funds, but negligible credit risk.
• Prime money market funds: Invest in a broader range of instruments including corporate commercial paper, bank CDs, and other high-quality short-term corporate debt in addition to government securities. Offer slightly higher yields than government funds but carry marginally more credit risk. Institutional prime funds now have floating NAVs and can impose fees or gates under stress.

For most individual investors, a government money market fund at a major brokerage (like Vanguard Federal Money Market, Fidelity Government Money Market, or Schwab Government Money Fund) is the appropriate choice for cash management—safe, liquid, and competitive yield.