Money Market Funds and Constant NAV
A money market fund is designed to keep its share price pinned at a round number like $1.00 no matter what its underlying assets are actually worth — a convenient fiction that works until it doesn't.
Prerequisites: The Money Market and the Short End of the Curve
Most funds' share prices float with the market value of what they hold. A traditional money market fund (MMF), by design, does something unusual: it tries to keep its share price fixed at exactly $1.00, even as the value of the bonds and commercial paper it holds moves around slightly every day. Investors put in a dollar, expect a dollar back plus a bit of interest, and never see the share price move. That fixed $1.00 is the constant net asset value (CNAV), and it is a deliberate accounting convention, not a law of nature.
A constant-NAV fund rounds its share price to $1.00 using amortized-cost accounting as long as the fund's true, mark-to-market value stays within a narrow band of that dollar — the moment true value drifts far enough away, the fund must "break the buck," and the fiction of a riskless dollar disappears exactly when investors need it most.
How the $1.00 is maintained
Rather than marking its short-term holdings to market every day, a traditional MMF uses amortized cost accounting: a bond bought at a small discount or premium has its price straight-lined toward face value over its remaining life, smoothing out small day-to-day market fluctuations. As long as the fund's true, market-based NAV per share stays within a small tolerance of $1.00 (historically 0.5%, i.e. $0.995 to $1.005), the fund reports $1.0000 and investors transact at that flat price. If true value ever drifts outside that band, the fund must reprice — famously called "breaking the buck."
Worked example
A prime MMF holds commercial paper from an issuer that suddenly defaults, representing 1.2% of the fund's assets.
- Before the default, true mark-to-market NAV was $0.9990 per share — already near the bottom of the historical 0.5% tolerance band but still reported as $1.0000.
- The default forces a writedown of that 1.2% position to near zero, pulling true NAV to roughly $0.9878 per share — outside any reasonable tolerance for rounding to $1.00.
- The fund breaks the buck, now reporting and redeeming at $0.9878. Investors who believed they held riskless $1.00 cash equivalents suddenly realize a loss, and because everyone rushes to redeem before the fund reprices further, the fund faces a run exactly like a bank facing a deposit run.
This is essentially what happened to a major fund in 2008 after it held debt from a failed financial institution — the visible event that triggered a broader freeze in short-term credit markets and, ultimately, reforms requiring many institutional prime funds to switch to a floating NAV.
What this means in practice
Post-crisis reforms in several jurisdictions require institutional prime and municipal MMFs to use a floating NAV (reporting true, mark-to-market value daily, no rounding to $1.00) precisely because the constant-NAV convention had created a false sense of safety that triggered runs when broken. Retail and government-only MMFs in some regimes still use CNAV, on the argument that their holdings (government securities) are safe enough that the tolerance band is very unlikely to be breached. Cash managers choosing between fund types are really choosing between the operational convenience of a fixed $1.00 and the more transparent, if less psychologically comfortable, floating-NAV alternative.
A $1.00 constant NAV is an accounting convention, not a guarantee — money market funds are not FDIC-insured deposits, and "breaking the buck" is a rare but real possibility whenever the fund's actual holdings lose enough value that amortized-cost rounding can no longer paper over the difference.
Further reading
- SEC, Money Market Fund Reform Rule 2a-7 Adopting Release