A federal money market fund is a mutual fund that keeps at least 99.5% of its assets in cash, U.S. government securities, and fully collateralized repurchase agreements, with the goal of holding its share price steady at $1.00.1eCFR. 17 CFR 270.2a-7 – Money Market Funds The SEC’s formal name for the product is “government money market fund,” and the industry uses “federal” and “government” interchangeably. You earn modest interest on cash you want to keep safe and liquid, and the portion of income that comes from Treasury securities is exempt from state and local income tax.
What the Fund Holds
Three asset types do nearly all the work.
Treasury bills are the core holding. Bills are short-term government debt sold at a discount: you pay less than face value, and the Treasury pays the full amount at maturity. The Treasury auctions bills in seven standard terms — 4, 6, 8, 13, 17, 26, and 52 weeks — plus occasional cash management bills with variable terms.2TreasuryDirect. Treasury Bills – FAQs
Agency securities are the second category. These come from government-sponsored enterprises such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).3Board of Governors of the Federal Reserve System. Money Market Funds: Investment Holdings Detail Agency bonds don’t carry the full-faith-and-credit backing that Treasuries do, but SEC rules count them as government securities, and they typically add a bit of yield.
The third piece is repurchase agreements, or repos. The fund buys government securities from a counterparty and agrees to sell them back at a slightly higher price, often the next day. To satisfy Rule 2a-7, these repos have to be fully collateralized by government debt.1eCFR. 17 CFR 270.2a-7 – Money Market Funds
Rule 2a-7 also caps how long these holdings can run. Any single security has to mature within 397 calendar days. At the portfolio level, the dollar-weighted average maturity cannot exceed 60 days, and the dollar-weighted average life cannot exceed 120 days.4GovInfo. Securities and Exchange Commission 270.2a-7 Short durations keep the fund tracking current interest rates and limit the price impact of rate moves on existing holdings.
On top of maturity limits, the fund must stay liquid enough to meet redemption waves. Following reforms the SEC finalized in 2023, government money market funds must keep at least 25% of total assets in daily liquid assets (maturing within one business day) and at least 50% in weekly liquid assets.5SEC.gov. Money Market Fund Reforms Those floors jumped from the earlier 10% and 30% minimums after liquidity stress events in 2008 and 2020.
How the $1.00 Share Price Stays Stable
The stable share price is the defining feature, and it depends on two accounting methods the SEC allows these funds to use. The amortized cost method values each security at its purchase price plus the gradual accretion of any discount, ignoring day-to-day market swings. Penny rounding lets the fund round its per-share net asset value to the nearest cent, so small market movements don’t push the reported price off $1.00.1eCFR. 17 CFR 270.2a-7 – Money Market Funds
After 2014 SEC reforms, institutional prime and tax-exempt funds lost access to those methods and had to adopt a floating NAV that moves with market value. Government money market funds kept the stable $1.00 price, and that difference pulled a lot of institutional cash into the government category.
While the share price doesn’t move, interest income accrues every day and is paid out monthly as ordinary dividends. Depending on how you’ve set up the account, your share count grows or you receive a cash distribution. The yield shows up in your balance, not the price per share.
What You Earn and How It’s Taxed
The standard performance figure is the 7-day SEC yield, which annualizes the income earned over the previous seven days after fund expenses are deducted. Every money market fund reports this number, so it’s the cleanest way to compare funds against each other. Money market funds calculate the figure using a specific formula prescribed by the SEC in Form N-1A.
Also look at the expense ratio, the annual fee the fund charges as a percentage of assets. Many fund companies waive part of their fees, so you’ll usually see two numbers: the gross expense ratio (the full contractual fee) and the net expense ratio (what you actually pay after the waiver). Waivers can be removed, so a low net ratio sitting on top of a much higher gross ratio can rise later.
Income from a federal money market fund is treated as ordinary dividends and reported on Form 1099-DIV.6Internal Revenue Service. About Form 1099-DIV, Dividends and Distributions For federal tax purposes, you’ll pay at your ordinary income rate, which ranges from 10% to 37% for 2026 depending on taxable income and filing status.7Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
The real tax advantage is at the state level. Federal law exempts interest on direct obligations of the United States from state and local income taxes.8Office of the Law Revision Counsel. 31 USC 3124 – Exemption From Taxation So the share of your dividends that came from Treasury bills avoids state tax. Income from repurchase agreements and agency securities generally doesn’t qualify, because those aren’t direct obligations of the U.S. government.
Fund companies publish annual tax information showing the percentage of income that came from qualifying Treasury obligations. If the fund held 80% Treasuries during the year, roughly 80% of your dividends would be state-tax-exempt. Some states require the fund to meet a minimum Treasury threshold before granting any exemption, so check your state’s rules.
What Can Go Wrong
These funds sit at the conservative end of investing, but they aren’t risk-free, and they aren’t bank accounts.
- No FDIC insurance. Unlike a bank money market deposit account, a money market mutual fund carries no federal deposit insurance. The $1.00 share price is a goal, not a guarantee.
- SIPC covers brokerage failure, not investment losses. If your brokerage firm fails, SIPC protects up to $500,000 per account, including a $250,000 limit for cash. Money market fund shares count as securities under SIPC coverage. SIPC does not protect against a decline in the value of those shares.9SIPC. What SIPC Protects
- Interest rate risk is small but real. When rates rise, existing fixed-rate holdings lose a bit of value. The 60-day average maturity cap and amortized cost accounting limit the exposure without eliminating it.
- Inflation risk. Money market yields often trail inflation, so your nominal balance stays steady while your purchasing power slowly erodes.
When a money market fund’s NAV drops below $1.00, it’s called “breaking the buck.” That outcome is extremely rare for government funds given what they hold. The most famous case was the Reserve Primary Fund in September 2008, a prime fund that held Lehman Brothers commercial paper and couldn’t maintain its $1.00 share price after Lehman’s collapse. That event triggered waves of redemptions across the industry and prompted every major round of reform since.
How It Differs From a Prime Money Market Fund
If you’re comparing products, the line to watch is the 99.5% rule. A government money market fund has to keep 99.5% or more of total assets in cash, government securities, or fully collateralized repos. A prime money market fund can hold corporate debt like commercial paper, which can push yield higher but also brings credit risk the government category avoids.
The SEC’s 2023 reform package added mandatory and discretionary liquidity fees for prime and tax-exempt funds under stress conditions. Government money market funds are exempt from both the mandatory and discretionary liquidity fee requirements, and funds can no longer suspend redemptions altogether the way the old rules permitted.5SEC.gov. Money Market Fund Reforms That exemption is one of the practical reasons large investors have shifted toward government funds: in a stress period, you can redeem freely without a surprise fee.