Are There Money Market ETFs & How Do They Work?
Understand exchange-traded funds designed for capital preservation and liquidity, and how they fit into your financial planning.
Money Market Exchange-Traded Funds (ETFs) offer a way to manage cash within an investment portfolio. These financial instruments offer a means to preserve capital and maintain liquidity while potentially generating modest income. They are an alternative to traditional savings accounts or money market mutual funds for short-term cash holdings. This article explains Money Market ETFs, distinguishes them from other cash vehicles, and outlines how to access them.
Understanding Money Market ETFs
Money Market ETFs invest in short-term, highly liquid debt instruments. These funds aim for capital preservation and liquidity, typically seeking to provide a yield that is competitive with short-term interest rates. Money Market ETFs achieve their objectives by investing in a portfolio of high-quality, low-risk securities such as U.S. Treasury bills, commercial paper, certificates of deposit, and short-term corporate debt. The securities held within these funds generally have short maturities, contributing to their stability.
Unlike traditional mutual funds, Money Market ETFs trade on stock exchanges throughout the day. This real-time trading means their share price can fluctuate based on market supply and demand, as well as the underlying value of their assets. Investors buy and sell shares at market prices, which may involve a bid-ask spread. The income generated by these ETFs, usually from interest payments on their underlying debt securities, is typically distributed to shareholders.
The returns from Money Market ETFs are generally taxed as ordinary income. Any capital gains realized from selling ETF shares are subject to capital gains tax rules. If shares are held for one year or less, gains are taxed as short-term capital gains at ordinary income rates, while gains on shares held for more than one year are subject to long-term capital gains rates. Certain Money Market ETFs that invest primarily in municipal securities may offer federal tax-exempt income, and in some cases, may also be exempt from state and local taxes, depending on the specific state’s regulations.
Distinguishing Money Market ETFs from Traditional Money Market Funds
Money Market ETFs share similarities with traditional money market mutual funds (MMFs) but possess distinct operational differences. Both focus on capital preservation and liquidity by investing in short-term, high-quality debt instruments. However, their trading mechanisms and pricing structures set them apart.
Traditional money market mutual funds are typically bought and sold once a day, after the market closes, at their net asset value (NAV). Most traditional MMFs, particularly retail and government funds, aim to maintain a stable $1.00 NAV per share, providing a consistent value for investors. This stable NAV is a hallmark of these funds, although it can be subject to regulatory changes or market stress. Money market funds are governed by the Securities and Exchange Commission (SEC), which mandates strict requirements for portfolio quality, maturity, and liquidity to support their stability.
In contrast, Money Market ETFs trade on exchanges throughout the trading day. This intraday trading means their share prices fluctuate based on market forces, and they do not typically maintain a stable $1.00 NAV. Instead, Money Market ETFs operate with a floating NAV, reflecting the real-time market value of their underlying securities. While both types of funds are liquid, the liquidity for ETFs is accessed through exchange trading, offering the ability to buy or sell shares at any point during market hours. Accessing MMFs usually involves direct transactions with the fund provider or through a bank, whereas ETFs require a brokerage account for trading.
Accessing Money Market ETFs
Investing in Money Market ETFs requires establishing an account with a brokerage firm. These accounts enable individuals to buy and sell various securities, including ETFs. Most brokerage firms do not impose an account minimum to begin, though specific investment minimums may apply to certain products.
After opening a brokerage account, the next step involves funding it. Investors can typically deposit money into their brokerage account through various methods, such as electronic transfers from a bank account (ACH), wire transfers, or direct deposits. Once the account is funded, investors can search for specific Money Market ETFs by their ticker symbols.
Many brokerage platforms offer tools and research resources to help identify suitable ETFs. When placing an order to buy Money Market ETF shares, investors have options such as market orders or limit orders. A market order executes immediately at the prevailing market price. A limit order, conversely, allows an investor to specify the maximum price they are willing to pay, ensuring the order only executes if the ETF’s price reaches that level. After the order is placed and filled, the ETF shares will be held within the investor’s brokerage account. It is important to consider the expense ratio of an ETF, which represents the annual cost of owning the fund, as this impacts the overall return.