Money market funds are a type of open-ended debt funds with high liquidity and short-term investment horizon. These funds invest in debt securities with high credit ratings, bringing stability and diversification to your portfolio.
In this article, we will highlight the features and advantages of money market mutual funds.
Money markets are the financial markets that deal with short-term lending and borrowing with up to one year of maturity period.
The key instruments in money markets are:
Treasury Bills (T-Bills): The RBI issues T-bills to raise money for a duration of up to 365 days.
Certificate of Deposits (CDs): Scheduled commercial banks offer CDs for a specific tenure in a dematerialized form. CDs are similar to FDs with a lock-in, i.e. you cannot withdraw CD before the maturity.
Commercial Papers (CPs): Companies and financial institutions release commercial papers to raise money for a short duration. CPs have high credit ratings and are usually available at discounted prices.
Repurchase Agreements (Repos): RBI lends money to commercial banks in the form of repos.
Money market funds invest in low-risk short-term debt instruments such as treasury bills, commercial papers, repos, etc. The maturity period of the underlying assets ranges from one day to one year. These funds are suitable to introduce stability to your portfolio while generating a source of income through interest.
Money market funds are highly liquid with underlying assets maturing within a year. These funds are better suited for 6 months to 1 year of investment horizon.
Low Interest Rate Risk
Debt funds are prone to interest rate risk as when the interest rate goes up, bond prices go down. Therefore, the longer the maturity of a debt fund, the higher the interest rate risk. As money market funds have a short maturity period of up to one year, the interest rate risk is low.
Stability
Short-duration debt instruments are known for low volatility. That is, the value of these funds does not fluctuate drastically. These funds are stable and ideal for investors seeking principal protection.
Superior Returns Compared to Savings Account/Fixed Deposit
These funds tend to deliver superior returns than bank FD or savings accounts for a similar duration. However, the returns are lower than long-term debt funds.
Risk
Though money market funds carry relatively lower risk, these funds are prone to interest rate risk and market fluctuations. These funds may also carry reinvestment risk. As the funds invest in new securities as and when the old ones mature, the reinvestment may happen at a lower interest rate.
Money market funds are only suitable for 3 months to a year of investment. If you are planning for a longer investment horizon, you can explore other debt fund categories such as dynamic bond funds, medium to large-duration debt funds, etc.
Always ensure the exit load and the expense ratio associated with any mutual fund. Read the fund-related documents carefully before investing.
Capital gains earned from these funds attract tax. The payable tax depends upon the investment duration. Short-term capital gains tax will be applicable for investments redeemed before 36 months. Otherwise, you’ll have to pay long-term capital gains for investments held for more than 36 months.
In the case of debt funds, both STCG and LTCG are taxed at your tax slab.
Money market funds are ideal for investors seeking liquidity and short-term investment avenues. These funds are ideal to park your surplus funds instead of keeping them in a bank account. You can leverage these funds to build an emergency fund of up to one year. Investors with low to moderate risk appetite can consider these funds to mitigate equity investments.
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Money market funds are a perfect fit for investors seeking liquidity, low risk, and stable returns. These funds can be a part of your emergency funds or a short-term financial goal. Rather than keeping your funds in a savings account, you can utilize these funds to earn superior returns.
It is important to note that, while these funds are safe, they’re not entirely risk-free. Make sure you evaluate your financial goals and risk appetite while investing. If you’re unsure whether to invest in debt funds or not, get in touch with us. Our experts will review your portfolio and help you realign it with your financial goals.
