What are money market funds?

A money market fund is an investment fund that invests in very short-term and low-risk financial instruments. These come from the money market, which is a part of the financial system where institutions such as banks, companies or governments lend and borrow money for short periods. Typically, this means anything from a few days up to a year. The interest rates on these loans are closely tied to the European Central Bank’s key interest rate.

When you invest in a money market fund, your money is pooled together with that of many other investors and used to provide these short-term loans. You can think of it as temporarily lending money to various trusted borrowers. This process is managed and diversified by a professional fund.

In return, the fund earns interest, which is passed on to the investors as a return. The value of a money market fund can fluctuate slightly as it mimics the ECB rate, but generally remains very stable. For people looking to park their money somewhere with flexibility and limited risk, this stability makes it an appealing option.

You may also hear the term ‘overnight rate swap’ or ‘overnight index swap’, which refers to the exchange that occurs between the two parties (investor/lender and institution/borrower). This is a form of derivative contract, which means it is based on short-term interest rates but doesn’t represent an actual investment in an asset. The Peaks Interest account is an example of an investing product that deals in synthetically-backed overnight rate swaps like this. 

Money market funds have gained in popularity

Between 2015 and 2021, money market funds offered very little return due to historically low and even negative interest rates. Many people left their money in current or savings accounts, as even the effort to invest in a fund didn't seem worth it.

That changed in 2022 when the European Central Bank began raising interest rates to counter inflation. As a result, interest rates on the money market rose significantly, and money market funds became relevant again. In 2024, the ECB cut rates again as price increases slowed.

For many investors, this brings back the question of where to store savings in the short term. For instance, if they are planning a major purchase in the next one to two years or are not yet ready to take on more market risk an investor might opt to invest in a money market fund rather than other forms of investing.

Who are money market funds for?

Money market funds are best suited for people looking to invest their money for a short or defined period without locking it away long term. For example, someone planning a renovation, a training course or a family event in the next year or two might want a low-risk way to hold that money while still earning some interest.

They are also useful for anyone building a balanced investment portfolio. If part of your money is already in stocks or ETFs, a money market fund can help reduce overall portfolio risk by providing a stable counterweight.

Beginner investors often use money market funds to gain initial experience with investing. With minimal fluctuations and a straightforward structure, these funds offer an easy entry point into the world of investment. If you're still figuring out how much to set aside regularly, try following the 50/30/20 rule to create an investing or saving habit that matches your lifestyle and goals.

How does a money market fund work?

The composition and operations of a money market fund are strictly regulated. These funds invest exclusively in short-term financial assets, such as: 

• short-term bank deposits
  
  
  
  
• corporate deposit certificates
  
  
  
  
• short-term government securities, like treasury bills
  
  
  
  

Each investment in the fund must be repaid within 397 days or less. This short timeframe means the fund’s money is not tied up for long, so it can quickly react to changes in interest rates. It also helps keep the fund flexible and makes it easier for investors to access their money when needed. Investments are spread across multiple borrowers, which reduces the impact if one issuer encounters financial difficulties.

You can think of the fund as a basket filled with very short-term, reliable loan agreement, diversified across multiple institutions for added stability.

The key differences between using a money market fund and a savings account.

Money market funds and overnight rate swaps (like the Peaks Interest account) often appeal to people who want to avoid frequently switching accounts to chase the best interest rate, as these funds follow market trends automatically. The most important thing to remember is that a money market fund is investing and a savings account is not. As with any type of investing, a money market fund carries the risk of losing some or all of your invested money.

If you're deciding between a money market fund (or similar swap product) and a savings account, both can offer safety and short-term flexibility but differ in structure and detail. These are some typical differences and similarities. Please be advised these features are not representative for all accounts, so be sure to check your own service provider for more information. 

While the table above compares money market funds with savings accounts (and not with products based on overnight index swaps like the Interest Account), it’s good to know that both money market funds and overnight index swaps aim for the same thing: tracking short-term interest rates. The main difference is how they do it and the risks involved — money market funds directly hold short-term debt, while a swap-based ETF uses financial contracts to mimic those returns. This also brings in what’s called counterparty risk, which simply means there’s a small chance the bank or institution on the other side of the contract might not be able to meet its obligations.

Money market fund ETFs

Alongside traditional funds, there are also exchange-traded funds (ETFs) that track money market rates. These money market ETFs often follow an index like the Euro Short-Term Rate (€STR). This is a benchmark that reflects average overnight interest rates among major European banks.

Some use swap agreements to replicate index performance.The Peaks Interest account is one such example. It tracks the Xtrackers II EUR Overnight Rate Swap UCITS ETF 1C, an index that reflects the return on a deposit bearing interest at the €STR rate + 8.5 basis points. 

In this case, the fund enters into a contract with a bank that guarantees the target return. While this method is efficient, it introduces what’s called counterparty risk. This refers to the chance that the bank might default. However, according to ESMA, this risk is generally considered low, especially for large institutions.

When you use the Peaks Interest account, the money you invest is held at Deutsche Bank and 100% backed by bond collateral.

Risks and key considerations when investing in the money market

Money market funds are stable, but not risk-free. It’s important to be aware of the following:

• Credit risk: if one of the banks, companies, or governments that borrowed money from the fund cannot pay it back.
  
  
  
  
• Interest rate risk: if the European Central Bank lowers short-term rates, the return you get from the fund will also fall.
  
  
  
  
• Liquidity: although money market funds are designed to be very liquid, it usually takes 1–4 business days to get your money back.
  
  
  
  

Overnight rate swaps also require about 1-4 days to withdraw your money, but also carry different risks:

• Counterparty risk: the small chance that the bank on the other side of the contract cannot meet its obligations.
  
  
  
  
• Derivatives risk: because the return is created through contracts, the product depends on how well those agreements are managed and collateralised.
  
  
  
  

To reduce these risks, regulations require that the bank provides collateral (for example bonds) to back the value of your investment. In the case of the Peaks Interest account, your money is 100% covered by bond collateral.

In the case of both money market funds and overnight rate swaps, if you know you’ll need access to your money on a specific day, it’s wise to maintain a buffer on your bank account.

Is a money market fund an option for you?

In summary, for investors looking to set money aside with daily interest and flexible access, money market funds and similar products can be an appealing option, especially when stability and short investment are important.

These types of investments deal in high-quality, short-term debt instruments, offering a balance between safety and liquidity. While returns may be modest compared to riskier investments, money market funds and overnight rate swaps can provide peace of mind and easy access to your cash, making them a practical choice for managing short-term financial goals.

Disclaimer: Peaks is an execution-only service and does not provide personalised financial advice. The content of this article is for informational purposes only. Investing always involves risk, including the possible loss of your investment.