Index Funds vs. Money Market Funds

Personal Finance
a stack of coins denoting the gains from money market funds and index funds

Knowing how to invest your money is important. Participating in the stock market through index funds seems safe, but nothing beats the low-risk advantage of a money market fund. Our comparison of the two accounts could help you start investing and stop worrying.

Risk

Investors looking for a low-risk way to spend their money should consider money market funds. While the gains aren’t ridiculously high, money market funds are very safe. The only more reliable method of saving is to deposit money into a savings account. Even though the federal government doesn’t insure investments, the United States Securities and Exchange Commission keeps a close eye on them. Rules are in place for the purpose of providing more stability and resilience.

Index funds aren’t incredibly risky, but there’s still a chance that investments could underperform and lose money. Index funds mimic larger stock markets. This means that if pegged markets drop, so will your index fund. Diversification helps limit the risk, but it doesn’t offer shelter from a bubble.

Gains

When participating in the stock market, higher risk equals a higher possibly of large returns. Money market funds are designed to be short-term ways to achieve capital gains, but they lack the ability to earn high-yield returns. These types of funds have a range of 1% to 3% in returns. This doesn’t mean you’ll always receive a 3% return on your investment, however. It’s merely a chance.

Index funds mimic larger markets, so they’re fluid like the stock market. It’s possible to get a 10% increase one day only to see it fall the next. The percentage of gains is highly dependent on the fund’s securities and assets. Index funds also allow investors to create a balanced portfolio that protects them against risk because it’s possible to buy and sell fractional units. This may decrease gains but make the portfolio less risky.

Liquidity

Money market funds are unique. To receive payments from returns or capital gains, an investor can simply write a check and transfer the money into a checking account when needed. This makes money market accounts more like savings accounts than an actual stock or security. For investors who need access to their money at all times, money market accounts are the easiest way to go.

Index funds are much more like trading on the stock market. If you wish to liquidate your index funds, you must sell the shares. The shares cannot be traded in the middle of the day and must wait until the end-of-day pricing. After the shares are sold, the broker or account manager will pay the investor in cash.

Fees

There are several fees investors should be aware of when thinking about investing in a money market fund. While typically small, hidden fees on balance requirements or specific transactions can increase the cost. This may outweigh the value of the money market fund, making an index fund more appealing.

Index funds are notoriously cheap, and one of the most inexpensive ways to participate in the stock exchange. This is because it is a “passive” investment, meaning a manager doesn’t have to monitor the fund actively. However, like a money market fund, knowing with whom to invest can change the affordability of index funds. For example, management fees can vary from as low as 0.05% to well over 2% and beyond.

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