What are money market funds?

Money market funds (MMFs) are open-ended mutual funds that invest in short-term, relatively low-risk/low-to-moderate risk, and highly liquid securities. These funds primarily focus on mitigating risks while providing a potentially reasonable return, making them a suitable choice among investors seeking relative stability and liquidity.

Money market funds operate on the principle of pooling funds from various investors and investing them in a diversified portfolio of money market instruments. Individuals and institutions invest their money in a money market fund by purchasing units. These funds can also assist in diversifying an investor's portfolio.

Table of Contents

• What are money market funds?
• Types of money market instruments
• Who should invest in money market funds
• Factors to consider before investing in money market funds
• Guide to investing in money market funds
• Risk mitigation with money market funds
• Role of Money Market Funds in Volatile Markets

What are money market funds?

Money market funds belong to the category of mutual funds that focus on short-term, high-quality debt instruments. These financial instruments encompass Treasury Bills, Certificates of Deposit (CDs), Commercial Paper (CPs), and various other money market instruments issued by governments, banks, and corporations. Thus, the main aim of money market funds is to offer investors a relatively stable return potential and high liquidity.

Types of money market instruments

Money market funds typically invest in a range of money market instruments, which are short-term debt securities with maturities usually ranging up to one year.

Here are some common types of money market instruments:

Treasury bills (T-Bills)

These are short-term government securities with maturities ranging from 91 days to 364 days. T-Bills are considered one of the relatively stable investments as they are backed by the government's creditworthiness.

Commercial paper (CP)

Commercial paper is an unsecured, short-term debt instrument issued by corporations to raise funds for their working capital needs. It typically has maturities of 7 days to 1 year.

Certificate of deposit (CD)

CDs are time deposits offered by banks and financial institutions. They have fixed maturities and typically offer reasonable interest rates.

Repurchase agreements (Repos)

In a repo transaction, an MMF purchases securities from another party with an agreement to sell them back at a specified date and price. It is a short-term collateralised lending/borrowing arrangement.

Commercial bills

Commercial bills are short-term, negotiable debt instruments used by businesses to finance their working capital requirements.

Who should invest in money market funds

Individuals with a short-term investment horizon of upto one year and a need for high liquidity may consider investing in money market funds.

Furthermore, investors with a low appetite for risk and who seek reasonable returns than traditional investment options such as fixed deposits can place their investable funds in money market funds. These schemes provide a relatively better return potential in the short term.

However, if you have a long-term investment horizon, money market mutual funds may not be suitable for your objectives. Instead, you should consider investing in dynamic bond funds or balanced advantage funds. To see how even a short-term investment could perform, a lumpsum calculator can provide a useful projection of potential earnings.

Factors to consider before investing in money market funds

Factors to consider before investing in money market funds

Investment horizon: The relatively low volatility and short-term maturities of money market fund makes them suitable for shorter time horizons.

Returns: While higher than a basic savings account, MMFs don't provide extravagant returns. Also, unlike savings account, the returns are not guaranteed and depend upon market conditions.

Liquidity: You can withdraw your funds at any time without penalty, offering peace of mind for unexpected expenses.

Expenses: MMFs typically have low expense ratios, but comparisons are still useful. Lower expenses can translate to relatively better net returns, so scrutinise them carefully.

Taxation: Interest and capital appreciation from MMFs is taxable in India. Factor this into your calculations to understand your actual returns

Guide to investing in money market funds

Investing in money market funds is a straightforward process. Here's a step-by-step guide:

KYC compliance: Ensure that you are KYC (Know Your Customer) compliant by submitting the necessary documents to a registered KYC registration agency.

Choose a fund: Research various money market funds and select the one that aligns with your financial goals and risk tolerance.

Fill out application form: Obtain the fund's application form from the asset management company or mutual fund distributors. Fill it out with accurate details.

Nomination: Nominate a beneficiary or opt out of nomination are two options available. Consider nominating a beneficiary for your investment to ensure a smooth transfer of funds in case of any unfortunate event.

Investment amount: Decide on the amount you wish to invest in the fund and make the payment through check, demand draft, or online transfer.

Monitor and review: Regularly monitor the performance of your money market fund and review its alignment with your financial goals. You can seek the advice of a financial expert to make a sound decision.

Risk mitigation with money market funds

Let's understand how money market funds can contribute to risk mitigation:

• Relative stability of capital: Money market funds primarily invest in short-term, low-risk securities like Treasury bills and certificates of deposit. This focus on relative stability provides cushion against erosion of capital, making these funds a go-to choice for investors who prioritise low-risk investments.
• Liquidity management: A key feature of money market funds is high liquidity. This liquidity feature helps investors access their money quickly, reducing the impact of sudden market movements or emergencies.
• Return potential: While money market funds may not offer high returns compared to riskier investments, they aim to provide a potentially steady and predictable source of income. This consistency can be crucial for investors who prefer a steady income and limited impact on capital over the potential for higher returns.

Role of Money Market Funds in Volatile Markets

Stability

Money market funds can offer some relative stability amid market turbulence. These funds primarily invest in money market securities such as treasury bills, certificates of deposit, and commercial paper with a maturity of up to one year. Such funds have a relatively low credit risk and interest rate risk because of the high quality and short maturity of the underlying securities. Through such investments, money market funds strive to maintain a relatively stable Net Asset Value (NAV).

Liquidity

One of the key advantages of money market funds is their high liquidity. Investors can buy or sell units in these funds at any time and there are typically no redemption charges or exit loads. High liquidity is important during volatile market conditions as it gives investors swift access to their funds without significant costs or delays.

Risk

No investment is risk-free, but money market funds can be suitable for conservative investors as they entail relatively low risk. By investing in short-term securities with minimal credit risk, these funds aim to potentially mitigate any impact on capital invested and cushion investors from broader market fluctuations. Moreover, the diversified nature of money market fund portfolios helps mitigate specific risks associated with individual securities. The interest rate risk is also mitigated by the short maturity (up to one year) of the portfolio securities.

Return potential

Although money market funds prioritise relative stability and liquidity, they also seek to offer returns through interest payments received on their underlying securities. These funds have the potential to yield higher returns than those offered by traditional short-term savings avenues. However, returns are not guaranteed and may fluctuate based on market conditions.

FAQs:

What are money market funds, and how do they work?

Money market funds invest in short-term debt instruments like treasury bills and commercial paper. They aim to provide liquidity and relatively stable returns by investing in low-risk, short-maturity securities. Like any mutual fund, these funds are also subject to market risks.

Are money market funds a suitable investment for short-term goals?

Money market funds can be suitable for short-term goals, offering potentially better returns than savings accounts. However, unlike savings account, these funds don’t offer guaranteed returns. Market fluctuations can impact returns. Consider your risk tolerance and investment horizon.

How do money market fund returns compare to savings accounts?

Money market funds typically offer potentially higher returns than savings accounts due to investments in market-linked instruments. However, returns are subject to market risks and are not guaranteed, unlike savings accounts.

What are the risks associated with investing in money market funds?

Money market funds carry some risks, including credit risk (the issuer may default) and interest rate risk (fluctuations in interest rates can impact returns). Though considered relatively low-risk, they are not risk-free.

How can I choose a suitable money market fund for my investment needs?

Consider factors like expense ratios, fund manager experience, historical performance, and the fund's investment strategy. Align the fund's objectives with your financial goals and risk tolerance. Past performance is not indicative of future results.

How do changing interest rates affect money market funds?

Interest rates tends to have a direct impact on these funds. With any increase in the rate of interest, returns on money market funds also increase and vice versa. Investors are advised to seek assistance from their financial advisors while making any changes to their asset allocation pertaining to money market funds.

Can money market funds be used to park emergency funds?

Money market funds have liquidity and are also relatively stable. This makes money market fund a suitable option for emergency funds. However, it is advisable that investors evaluate factors such as financial goals and accessibility needs before using money market funds for this objective.

What is the minimum investment for a money market fund?

The minimum investment for a money market fund can vary depending on the fund provider and the specific fund in question. The minimum investment amount for the Bajaj Finserv Money Market Fund is Rs 1,000 for lumpsum as well as SIP.

Are money market funds completely risk-free?

No, money market funds are not entirely risk-free. While considered relatively low-risk, they are subject to market fluctuations and potential credit risk of the underlying securities. Loss of principal is possible, though rare.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.