The Hidden Risks in Money-Market Funds
According to ICI, total money-market fund assets reached $7.02 trillion as of June 25, 2025—up from just under $7 trillion a month earlier. Their stability and convenience have made them a go-to cash alternative. But beneath the surface, they carry structural risks that many investors overlook—especially during times of market stress.
This article explores the hidden vulnerabilities in money-market funds, including redemption risk, liquidity mismatches, and misleading yield expectations.
Key Takeaways
- Money-market funds are not guaranteed or insured like bank accounts.
- Large redemptions can trigger liquidity stress and pricing distortions.
- Yield expectations may mislead investors about the safety or consistency of returns.
- Regulatory reforms have reduced—but not eliminated—the risk of runs.
Why They Seem “Safe”—And Why That Can Be Misleading
Money-market funds invest in short-term debt: Treasury bills, commercial paper, and repurchase agreements. Under SEC Rule 2a-7, money-market funds may offer a stable $1.00 NAV per share as long as their ‘shadow price’ stays within $0.9950–$1.0050.
To many investors, this creates a sense of safety. There’s little price movement, yields are posted daily, and withdrawals are easy. But that surface calm can hide fragility when markets freeze.
During the 2008 financial crisis, the Reserve Primary Fund—one of the oldest money-market funds—‘broke the buck’ by falling below $1 NAV after exposure to Lehman Brothers debt. Panic selling followed. The Treasury intervened to stabilize the market. That episode led to sweeping reforms.
However, reforms didn’t eliminate structural mismatches—they just added gates, fees, and disclosures. In response to March 2020’s MMF runs, the Federal Reserve established the Money Market Mutual Fund Liquidity Facility (MMLF) on March 18, 2020—lending to banks against prime MMF assets to stem redemptions and restore calm.
Liquidity Isn’t Instant
While money-market funds appear liquid, their assets may not be. In normal markets, redemption requests are easily met. But in a crisis, funds may be forced to sell holdings quickly—often at a discount—to generate cash. This creates what’s known as liquidity risk: the possibility that short-term needs can’t be met without selling at a loss.
Many funds now hold liquidity buffers, but those buffers vary, and under stress, they can shrink fast.
- Hypothetical: “Imagine an institutional investor withdraws hundreds of millions from a prime money-market fund during a market panic. If others follow, the fund may need to sell commercial paper—possibly at a discount—triggering losses or the imposition of redemption gates.”
This is not just theoretical. It happened in both 2008 and 2020. Regulatory scrutiny continues, but systemic reliance on these vehicles remains high.
The Yield Illusion
In a rising rate environment, money-market fund yields can look attractive—sometimes over 5%. But these yields are variable and sensitive to central bank policy. More importantly, they can create a false sense of long-term value.
Money parked in money-market funds isn’t compounding at that yield forever. As soon as rates fall, so do yields. And unlike fixed-income instruments, these funds don’t lock in a rate.
So what? Some investors may overestimate their real returns or delay reallocation to longer-duration assets, chasing temporary yields. That delay can mean missed opportunities for capital growth.
Behavioral Bias: Yield-chasing is common. A person might stay in a money-market fund too long, anchored by the last high yield, even as market conditions shift.
Redemption Runs Still Happen
Even with reforms, redemption runs remain a structural concern. The risk is particularly acute in institutional prime funds, which can impose gates or fees during periods of high stress.
Retail investors may be protected from some of these mechanisms, but the core dynamic remains: if too many people redeem too quickly, funds may not have the cash on hand to meet demands smoothly. It’s a mismatch between perceived safety and actual liquidity.
How to Think About Money-Market Funds
Money-market funds can be useful for short-term cash management. But they’re not cash equivalents in the strictest sense. Investors may want to:
- Treat them as interest-bearing holding zones, not long-term investments
- Understand the underlying assets—Treasuries differ from commercial paper
- Be aware of exit rules: fees, gates, or settlement delays
- Stay alert to changing rate environments and fund disclosures
These steps don’t eliminate risk, but they can help reduce surprises.
