Are Money Market Funds Cash Equivalents?

The liquidity of a company’s assets or an individual’s portfolio is a key indicator of financial health. Central to this are cash and cash equivalents, which represent the most accessible resources on a balance sheet. A frequent question for both corporate treasurers and individual investors is whether money market funds fit into this highly liquid category. Their classification requires a closer look at financial reporting definitions.

Defining Cash Equivalents

U.S. Generally Accepted Accounting Principles (GAAP) define a cash equivalent as a short-term, highly liquid investment. This means it must be readily convertible to a known amount of cash and be so near its maturity that it presents an insignificant risk of changes in value from interest rate fluctuations.

The standard sets the maturity timeframe at three months or less from the date an entity acquires the investment. This “original maturity” is an important detail; a three-year Treasury note purchased three months before it matures would qualify, but that same note purchased two years ago would not. This rule ensures the instrument’s value is stable.

Common examples of instruments that meet these criteria include U.S. Treasury bills, high-grade commercial paper, and certain certificates of deposit. These assets are valued for their safety and the ease with which they can be converted into cash.

Understanding Money Market Funds

A money market fund (MMF) is a type of mutual fund whose primary objectives are to preserve principal and provide high liquidity. To achieve this, MMFs invest in high-quality, short-term debt instruments from governments, banks, and corporations. The portfolio of a typical money market fund includes assets like U.S. Treasury securities, certificates of deposit (CDs), and commercial paper.

The structure and holdings of MMFs are regulated by the Securities and Exchange Commission (SEC) under Rule 2a-7 of the Investment Company Act. In 2023, the SEC amended this rule to improve fund resilience, increasing minimum liquidity requirements to ensure funds can better manage large redemptions. The reforms also removed provisions for temporary redemption gates and fees, which were seen as encouraging investor runs during periods of market stress.

A defining feature of many money market funds has been the goal of maintaining a stable net asset value (NAV), historically priced at $1.00 per share. Funds often use the amortized cost method of valuation for their holdings, which smooths out minor price fluctuations and helps maintain this stable price.

The Classification of Money Market Funds

For accounting purposes, money market funds are classified as cash equivalents if they meet the specific criteria. Their strategy of investing in debt with very short maturities satisfies the three-month-or-less requirement, and their high liquidity means shares can be redeemed for cash daily. The structure of an MMF is designed to be readily convertible to a known amount of cash, often a stable $1.00 per share, which fits the definition and allows companies to report them on the most liquid line of their balance sheet.

This accounting classification, however, does not mean MMFs are without risk. There is a small risk that a fund could lose value, an event known as “breaking the buck,” where the net asset value per share falls below $1.00. Additionally, a new framework requires institutional prime and tax-exempt money market funds to impose mandatory liquidity fees if they experience significant daily net redemptions.

Distinguishing Money Market Funds from Money Market Accounts

A common point of confusion is the difference between a money market fund and a money market account. While their names are similar, they are fundamentally different financial products. A money market fund is an investment product offered by brokerage firms, whereas a money market account is a type of savings account offered by banks and credit unions.

This distinction carries a significant consequence regarding insurance and safety. Money market accounts at insured banks are protected by the FDIC for up to $250,000 per depositor. Money market funds are not FDIC-insured but instead fall under the protection of the Securities Investor Protection Corporation (SIPC).

SIPC protects against the loss of cash and securities held by a customer at a financially troubled brokerage firm, but it does not protect against investment losses in market value. Therefore, while a money market account cannot lose value, a money market fund carries a slight risk that its share price could fall.