Investors interested in the money market can access it most easily through money market mutual funds. However, smaller investors still need a rudimentary understanding of the Treasury bills, commercial paper, bankers’ acceptances, repurchase agreements, and certificates of deposit (CDs) that make up the bulk of money market mutual fund portfolios. In this article, we show you how money market funds work and how they can benefit you.
Types of MMMF
- Institutional Money Market Mutual Funds
- Retail Money Market Mutual Funds
Advantages of Money Market Funds
- Ideal for an investment horizon of at least 3-6months.
- Low chances of loss if someone stays invested for 6+ months.
- These schemes tend to give better returns than Bank Fixed Deposits of similar duration.
- Investing in a money market account is very simple. Mutual funds investors can open an account, deposit money and make withdrawals virtually at their convenience.
- The performances made by a money market funds is closely related to the interest rates that are laid by the Reserve Bank of India and the Central Bank of India. Therefore, when RBI raises the rates in the market, yields increase and money market funds assures to give good returns.
- Aditya Birla Sun Life Money Fund
- Nippon Money Fund
- HDFC Money Fund
Types of Money Market Instruments
Commercial Paper (CPs)
Commercial Papers are issued by companies and other financial institutions that have a high credit rating. This is also called as Promissory notes. The papers are issued at the discounted rate and redeemed at face value. The difference is the return that is earned by the investor.
Certificate of Deposit (CD)
Certificate Deposits are similar to time deposits like fixed deposits that are offered by scheduled commercial banks. The only dissimilarity between Fixed Deposit and Certificate of Deposit is that an individual is unable to withdraw Certificate of Deposit before its expiry.
Treasury Bills (T-Bills)
T-Bills are issued by the Indian Government to raise money for a short term of up to one year. This is considered to be the safest instruments as it is backed by a guarantee of government. The rate of return, also known as risk-free rate, is low on T-Bills when compared to other instruments.
Repurchase Agreements (Repos)
Repurchase Agreements are an agreement by which RBI lends money to commercial banks. These agreements involve both the sale and purchase of agreement simultaneously.
Risk: These funds face interest rate risk, credit risk and reinvestment risk. In interest rate risk, the prices of the underlying assets increase as interest rates decline and decrease as the interest rates rise. The fund manager invests in risky securities that have a higher probability of default to deliver higher returns.
Costs: Expense ratio denotes the fees that are charged by the Money Market Funds to manage an individual’s portfolio. SEBI had prescribed the maximum limit as 2.25%. An ideal fund is the one that keeps the expense ratio at the lower levels. As the assets under management (AUM) increases, the scheme reduces the cost of operations.
Return: A Money Market Fund gives more return than a savings account. However, there are no guarantees returns. The Net Asset Value (NAV) varies with the changes in an overall interest rate regime. A fall in interest rates increases the price of the assets and delivers good returns.
Investment Horizon: Money Market Funds are acceptable for very short-term investment horizons which could be from three months to one year. For medium-term horizons, an individual is required to invest in dynamic bond funds.
Financial Goals: If an individual needs to make EMI payments or invest additional cash during maintaining liquidity, money market funds come in handy. A small portion of the portfolio can be invested for diversification.
Tax on Gains: Investing in debt funds offers capital gains that are liable for taxation. The tax rates depend on the holding period, that is the duration an individual is invested in the fund. A Short-Term Capital Gain (STCG) is made for a period lesser than three months.
Long-term Capital Gains (LTCG) is made when an individual has invested for more than three years. STCG from money market funds are added to the income and taxed accordingly to the income slab. LTCG from money market funds is taxed at the rate of % after indexation and % without the benefit of indexation.