What are Money Market Funds?

Every type of investment comes with a risk. Anyone who even thinks of investing their money anywhere calculates the risks of investing first. People check on different websites for the risks involved in the stock or bond they are going to invest in. For example, suppose you are going to buy some shares of a specific company. 

 

Will you buy it just without any kind of research? No! Obviously you won’t. You will do thorough research on the same and the thing you will look at most precisely will be the risks involved. You will look at the past results provided by the company and the future predictions too. So, that’s how much one has to do before investing their money in some place. 

 

But what if I tell you that there is one class of mutual fund that is famous for its risk free nature? Won’t you rejoice?

 

Yes. so have a look at the “Money Market Funds”.

 

You must be wondering what they are. So, yes, wait a few minutes and by the end of this blog, you will become completely aware of this thing. Let’s dive in now and begin with what money market funds are.

 

What are Money Market Funds?

 

Fixed-income mutual funds that invest in debt instruments with short maturities and little credit risk are known as money market funds. Money market mutual funds are one of the most low-volatility investment options. Depending on the sorts of securities in which a money market fund invests, the income generated by the fund is either taxable or tax-free.

 

Money market mutual funds are a type of fixed-income mutual fund that invests in debt securities with short maturities and low credit risk. Money market mutual funds are one of the most low-volatility investment options. Depending on the sorts of securities in which the fund invests, the income generated by the fund can be either taxable or tax-free.

 

How Does a Money Market Mutual Fund Work?

 

To manage short-term liquidity needs, money market mutual funds (MMMF) are used. These are debt funds that are open-ended and exclusively deal in cash or cash equivalents. Money market securities have a one-year average maturity and are hence referred to as money market instruments.

 

Treasury bills (T-Bills), repurchase agreements (Repos), commercial papers, and certificates of deposit are among the high-quality liquid assets in which the fund management invests. Money market funds are primarily focused on earning interest for their investors. The basic goal of money market funds is to keep the fund's Net Asset Value (NAV) as stable as possible.

 

Must Read: 10 Best Mutual Funds to Invest

 

Types of Money Market Instruments

 

1. Certificate of Deposit

 

A certificate of deposit (CD) is a financial instrument given to consumers by scheduled commercial banks. A CD allows a person to put money in the bank for a set length of time and earn a predefined rate of interest. The money and interest earned by the depositor cannot be withdrawn until the account has matured. A CD, unlike a fixed deposit, can be negotiated. The Reserve Bank of India sets its interest rates .

 

2. Treasury Bill

 

Fixed-income mutual funds that invest in debt instruments with short maturities and little credit risk are known as money market funds. Money market mutual funds are one of the most low-volatility investment options. Depending on the sorts of securities in which a money market fund invests, the income generated by the fund is either taxable or tax-free.

 

3. Repurchase Agreement

 

This refers to a short-term loan agreement between a commercial bank and the RBI, or between two commercial banks. Debt instruments are traded at a predetermined price and then acquired at a higher price at a later date, with the repo rate accounting for the difference.

 

4. Commercial Paper

 

Commercial papers are unsecured promissory notes issued by creditworthy financial institutions. They are sold to investors at a discount and are redeemed at face value when they reach maturity. CPs, which are considered high-return investments, often mature after 270 days.

 

5. Taxation

 

Money market fund gains are taxed the same way as debt fund gains. Capital gains tax applies to them. Money market fund units held for less than three years are subject to short-term capital gains tax, based on the applicable income tax bracket. A long-term capital gains tax of 20% indexation is imposed on holdings of more than three years.

 

Also Read: Liquid Funds: Working and Benefits

 

Who Should Invest in Money Market Funds?

 

By keeping a well-diversified portfolio of money market instruments, a money market fund aims to provide the maximum short-term income. These funds are appropriate for investors with a one-year investment horizon.

 

Money market funds are a good option for people with a low risk appetite who have extra cash in a savings account. These funds have the potential to pay out more money than a traditional savings account. Investment could include both corporate and retail investors.

 

If you're looking for a medium- to long-term investment, a money market fund isn't the best choice. Instead, you might invest in dynamic bond funds or balanced funds, which can provide you with higher returns.

   

Adjacent to this, please read: Ultra-short Bond Fund

 

Things to Consider before Investing

 

Risk

 

Interest rate risk, credit risk, and reinvestment risk all exist in money market funds. When it comes to interest rate risk, the underlying asset's price rises as interest rates fall and falls as interest rates rise. The fund manager may choose to invest in high-risk securities with a higher chance of default.

 

Return

 

Money market funds have the potential to provide better returns than traditional savings accounts. The profits, however, are not assured. The change in the overall interest rate regime affects the net asset value (NAV). Interest rates falling may cause an underlying asset's price to rise, resulting in favourable returns.

 

Costs

 

The price charged by fund houses to handle your investment is referred to as the costs expense ratio. The expenditure ratio has been set at 1.05 percent by SEBI. The scheme's cost of operations tends to decrease as the amount of assets under management (AUM) grows.

 

Horizontal Investment

 

Money market funds are best for short-term to extremely short-term investment goals, such as three months to a year. You can invest in other debt funds, such as dynamic bond funds, for medium-term goals.

 

Financial Objectives

 

Money market funds can be used to make EMI payments or invest surplus funds while keeping liquidity. For diversification, a modest amount of your portfolio can be invested in these.

 

Gain on Taxes

 

You can earn taxable capital gains by investing in debt funds. The tax rate is determined by the holding period, or the length of time you were invested in the fund. When you stay invested for less than three years, you make a short-term capital gain (STCG).

 

When you invest for more than three years, you earn long-term capital gains (LTCG). Money market funds' STCG is applied to your income and taxed according to your tax bracket. After indexation, LTCG from money market funds is taxed at a flat rate of 20%.

 

Conclusion 

 

The net asset value of Money market funds fluctuates when interest rates change. When money is withdrawn from money market mutual funds, an exit load is also applied. These funds' risks, such as interest rate and credit risks, are similar to those of debt funds. With all of these considerations in mind, investors can deploy a portion of their investment capital to money market funds and reap the benefits.