What are Money Market Funds?
In a world of super-low interest rates, many cash-heavy investors move their funds over to money market fund accounts. Money market funds returns are decent, and the accounts are safe. Money market funds are savings vehicles for View More
How a Money Market Fund Works?
The money market funds function just like a normal mutual fund. They offer redeemable shares or units to all the investors and get mandated to follow all the guidelines, which are drafted by the monetary regulators. View More
Besides that, the entire return through the money market funds also depends on the interest rates. These funds are designed to enable fund managers to generate much higher returns.
It also helps in keeping all the risks under control by adjusting the lending duration. When the loan tenure is high, you will certainly receive a much higher return without any issues.
Types of Money Market Instruments
The money market mutual funds are known as an exchange where cash-equivalent instruments and trade in cash occur. Instruments, which get traded in the money market, have different maturities, right from overnight to 1 year. So, what are these instruments? Let’s find out! View More
T-Bills [Treasury Bills]
The Indian Government has issued treasury bills [T-Bills] to increase the funds from a certain time to 365 days. These instruments are issued by the Government, and they are considered to be pretty safe.
But remember, since these instruments have fewer risks, the returns will also be lower. The return on treasury bills is much lower when compared with other types of market instruments,
Certificate of Deposit [CD]
The Certificate of Deposit is known as a term deposit. It’s provided by all the scheduled commercial banks that do not have the premature redemption option. The main difference between the FD and CD is that the CDs can be negotiated freely.
Repos [Repurchase Agreements]
Another instrument for the money market mutual funds is the Repurchase Agreements. These agreements are made between the RBI and a bank to facilitate all short-term loans. The agreement can also be made between two banks effectively.
CP [Commercial Paper]
Financial institutions and companies that have a high credit rating can easily issue commercial papers. These papers are unsecured and short-term promissory notes. It will enable all these entities to diversify all their short-term borrowing resources. The CPs are issued for a discounted rate, and the redemption occurs at face value. The investor gets to earn the difference.
Evaluating a Money Market Fund
When it comes to money mutual funds, it’s evaluated in a certain way. To do so, you have to take the net interest income earned by funds for the past 7 days. After that, subtract it by 7 days of the management fees and then divide it by the size of the fund’s investment over the next 7 days. Lastly, you have to multiply that amount by 365/7.
Who should invest in Money Market Funds?
Money market funds are designed for investors who want to preserve their principal and earn some interest in it. They may be appropriate for investors who: View More
Want to invest with minimal risk and high liquidity.
Have excess cash that they need to hold temporarily but don’t want to park it in a low-yielding account like a checking or savings account.
Want to save up for a large purchase or expense, such as paying college tuition or buying a house.
A money market fund is a safe place to park cash. These funds are known for safety, liquidity, and relative stability compared with other investments.
The following types of investors will benefit from money market funds:
Investors who want to keep their risk profile low should invest in money market funds. The chance of losing money is minimal as the investments are made in short term instruments that are highly liquid.
Investors who want stability and regular income should also invest in money market funds since they are highly liquid and provide stable returns. Money market funds can offer better rates than fixed deposits, making them more attractive for investors who want decent returns without taking any risks.
Any individual looking to park his idle cash can also consider investing in money market funds since they offer high liquidity and generate good money market fund returns.
Features of Money Market Funds
The money market mutual funds provide a safety net for short-term credit needs. It is the source of short-term finance for banks, financial institutions, and companies. The structure of the money market and the interest rates on various types of instruments depend on the demand for and supply of funds. View More
The best money market funds offer many benefits, which is why it is top-rated in India. These benefits are:
Money market funds provide an alternative to bank deposits for individuals and corporate investors. They offer better returns than bank deposits without much additional risk.
For corporates with surplus funds, investing in money market funds is a good option because it offers liquidity and better returns than bank deposits.
The main objective of money market funds is to preserve capital and offer liquidity at all times.
The minimum investment required is relatively lower than most of the other funds.
Taxability of Money Market Funds
Money market funds are treated as debt mutual funds and taxed accordingly. The capital gains tax is levied at income tax slab rates if the investments in money market funds were held for less than three years (short-term capital gains). View More
If the investment was held for more than three years (long-term capital gains), a 20 per cent tax with indexation is charged. Indexation helps reduce your tax liability by adjusting your cost inflation index (CII).
The tax treatment for best money market funds will depend on how long the investor has held the fund and whether the fund invests in corporate or federal debt instruments.
Money market funds return generated would be added to your gross income and taxed at your applicable slab rate. In addition, interest earned on debt mutual funds qualifies for indexation benefit. Indexation means that inflation is taken into account while computing long term capital gains (LTCG)
Risks involved with Money Market Funds
The most significant risk of money market funds is that their value can decrease, just like other investment securities. As with any investment, there are risks involved with money market funds. The primary risks include: View More
Interest rate risk: Money market funds are subject to interest rate risk. If interest rates increase, the value of the fund declines, and vice versa. Interest rate risk is usually greater when interest rates rise rather than fall.
Credit risk: Money market funds invest in debt securities such as commercial paper, bank CDs, and Treasury bills. These investments carry varying degrees of credit risk depending on the quality of the issuer and its ability to pay back principal and interest when due. The fund’s investment adviser attempts to diversify the credit risk among different issuers by investing in various types of debt instruments with varying maturities and credit ratings, but this may not always be successful.
Liquidity Risk: Money market funds are highly liquid, but some investments may face liquidity issues if investors start withdrawing their money en masse or if the issuer faces liquidity problems. If you face liquidity issues, you may have to sell your investment at a loss to raise cash.
Advantages of Money Market Funds
The primary objective of money market funds is to maintain liquidity and safety while offering higher interest than a savings account. Money market funds have advantages such as: View More
· Professional Management: Fund managers who care for your investments professionally manage these funds. They are experts and are paid to manage your money.
· Diversification: When you invest in a money market fund, your money is diversified across various investment options. This helps in reducing the risk associated with the investments.
· Liquidity: Money market funds are liquid as they invest in short-term securities, which can be converted into cash quickly. You can withdraw your investment at any time from these funds by placing a redemption request with the fund house.
· Higher Returns than Bank Accounts: When you compare interest rates on bank accounts with that offered by money market funds, you will find that these funds provide higher returns than bank accounts.
Disadvantages of Money Market Funds
Just like all the other funds in the market, the money market ones also come with several downsides. These are: View More
Money market securities are known to be susceptible towards volatility and are not insured by FDIC. This increases the chances of losing money, and whether it will be less it’s not guaranteed.
The probability of loss does exist, even when it’s generally pretty small. But there is no guarantee that investors will get funds for their share on the share’s redemption.
The money market fund returns are pretty lower compared to other funds that consist of assets like properties and stocks. There is a high possibility that the returns might fall beneath the inflation, which in return, will offer a negative return to all the investors. The interest rates might also become much lower, which will lessen the money market returns.
Redemption Gates and Liquidity Fees
This involves the imposition of high liquidity charges. These charges get levied on the sale of shares. The redemption gates need waiting periods right before the redeeming moves further from the money market funds. These are implemented to stop the run on the funds during times of market stress.
The Foreign Exchange Exposure
Another downside of the best money market mutual funds is the foreign market exposure. This particular risk is borne by all those funds that invest in the money market instruments across borders and are denominated in all other currencies than the home one.
Changes in the Environment
The changes taking place in government regulations and economic policies will result in an adverse impact on the cost of money market securities. It will also have an adverse impact on the financial standing of the issuers, which means they affect the fund supply and interest rates.
History of Money Market Funds
In India, the money market settlement fund was set up back in 1985 to increase the range of stock investments and liquidity. But it gained a lot more exposure in the country after the 1990s financial reform. View More
All the financial policies were modified in massive numbers, and the liberations were welcomed as new programmes. Restructuring the regularization system that existed before the 90s became a part of the new reforms.
This also reformed the way liquid cash was managed within the investment market. The latest development of this type of change led to the introduction of money market funds.
Even though it was a new section of mutual funds that didn’t exist before, it did pave the way for many fund managers. It has helped these managers to develop diverse and low-risk platforms to build opportunities for the traditional investors out there.
Treasury bills, certificates of deposit, commercial paper, term money and call money and forward contracts were all introduced. This was done to give a boost to this particular reform for the new government and monetary-enabled security policy.
Frequently Asked Questions
Are money market funds safe?
In short, yes, they are. The money market funds invest in short-term and highly stable debt securities, which have low risk. As the investments keep going, the money market mutual fund rates are viewed as safe, even when they are not completely risk-free.
Why can yields on money market mutual funds be very low?
The money market yields are pretty low because they hold up all the securities with maturities for up to 1 year.
Why doesn't the government offer insurance on money market mutual funds?
There is no insurance available on the money market funds because they are insured by FDIC or the federal government.
Is a money market account the same as a money market fund?
The money market accounts are deposit accounts, which are situated in banks. They are ideal for short-term savings and emergency funds that you want to access within a short time.
How short is "short term" for the securities in which money market mutual funds can invest?
The short term for all the securities where the MMF can invest is between 1 year to 3 years.