Don’t you wish there should be a safe investment option where you could park your money for small duration and earn decent returns? Don’t worry, money market mutual funds are here for you.
Let us consider a scenario that you have a large expense after a period of one year. At present, you have arranged the large sum already. Now, as per basic logic, is it worth to keep a large sum of money idle?
Money market mutual funds provide a safe and liquid investment option for earning returns in the short-term with very less risk.
In this article, we cover everything that you need to know about money market mutual funds. We will discuss about are money market mutual funds are, what are the different types, who should invest in these funds and much more.
In this article
- What are Money Market Mutual Funds?
- Key Features of Money Market Funds
- Money Market: Instruments
- Money Market Mutual Funds: Who Should Invest?
- Money Market Mutual Funds: Types
- Considerations as an Investor
What are Money Market Mutual Funds?
Money market mutual funds are those category of mutual funds that are safe, give some amount of returns and have good liquidity. It can be compared with a savings account with the facility to redeem without lock-in period and electronic money transfer.
Money market mutual funds come in hand to manage short-term cash needs. They are termed as money market instruments as these securities have an average maturity of one-year.
These type of funds invest the AUM in safe and good-quality liquid instruments. They invest in treasury bills, commercial paper, certificates of deposits and repurchase agreements.
Investment in money market mutual funds come in handy for emergency money requirement such as hospitalization expenses, vacation after a few months or even for living expenses in case the inflow of money is stopped.
Key Features of Money Market Funds
Following are the key characteristics of money market markets, which influence these mutual funds-
1. Trades are Executed Over the Counter
Money markets usually operate over the counter. Operating over the counter essentially means that such trades cannot be made online.
Therefore, a physical certificate is issued to the buyer of the money market instrument. Investment is made physically by authorized representatives or in person.
2. Bulk Buying and Selling
Bulk buying and selling means that money markets operate like wholesale units.
These markets accept bulk orders, thus retail investors participate less in these money markets. Fund managers make bulk purchases and sales in this scheme of markets.
3.Benefit of Diversification
Money market trade is investing in multiple instruments. This is contrary to capital markets which trade in only one type of instrument.
Moreover, the different instruments are unique in terms of different maturities, debt structure, credit risk and others. Therefore, money market instruments are ideal for diversification through the distribution of exposure.
4. Ease in Buying and Selling
High level of liquidity in money markets is one of their main USPs. It makes the entire buying and selling process faster and more convenient for all investors.
Money Market: Instruments
Money market mutual funds are considered safe and liquid because of the kind of securities that they invest in. In this section, let us understand what these instruments where these funds invest in are-
1.Money Market Mutual Funds
It can also be called liquid funds. Money market mutual funds are basically debt funds with the lowest possible risk.
Individual investors can access money markets via money market mutual funds. They can invest their money in a liquid fund, which invests in block over the counter deals in money markets.
Liquid funds usually invest in money market instruments with a maturity of up to 91 days. They provide higher returns than bank deposits and a not risky and very liquid.
2. Call Money
Call money represents a short term loan with maturities spanning a period which could range from 1 day to 14 days. Call money is repayable on demand.
Its features include fixed interest rate called- call rate. It is volatile due to being closely related to changes of demand and supply.
3. Treasury Bills
Treasury Bills or T-Bills are one of the oldest money market instruments. Issued by the Government of India, Treasury Bills are short term borrowing instruments.
The unique feature about T-bills is that they do not pay any interest. However, at the time of issue, they are available at a discount from their face value.
T-Bills are considered the safest form of investment as they are issued by the government. This is because they are considered to be zero default risk investments and the returns are guaranteed.
T-Bills are commonly classified on the basis of maturity and of type.
On the basis of maturity, treasury bills can be classified as 10 day T-Bills, 91 day T-Bills, 182 day T-Bills and 364 day T-Bills.
On the basis of type, treasury bills can be classified as auction bills and tap bills. These 2 bills are also termed as regular bills. This is because they are available for investment by banks as well as other participating institutions.
4. Ready Forward Contract (Repo)
Repurchase agreement or Repo is an agreement that simultaneously mentions sale and purchase of an asset.
Repo rate is the rate at which domestic Indian banks borrow from other Indian banks or from RBI. The repo rate is fixed by the Reserve Bank of India. It is very important to note that these agreements are made for short-term.
For borrowing agreements made internationally, LIBOR (London Inter-Bank Offered Rate) is used.
5. Interest Rate Swaps
This is a financial transaction in which two parties sign a deal in which one pays a fixed rate of interest, while the other pays a floating rate of interest.
The fixed rate of interest payable is calculated using a notional principal amount. The floating rate of interest, on the other hand, is paid on the actual principal borrowed. The rate usually varies on the basis of market conditions.
Such an arrangement protects the borrower from fluctuating interest rates changes.
Money Market Mutual Funds: Who Should Invest?
An investment in the money market fund provides the highest degree of short-term income (up to one year) at low risk-levels.
Thus, investing in money market mu+tual funds is suitable for investors with surplus cash in savings bank account and low-risk appetite.
The returns from money market mutual funds easily beats that of the savings bank account.
This investment option is so suitable for those who have a medium to long-term investment horizon. In that case, it is advisable that you invest in dynamic bond funds or balanced funds.
All in all, money market mutual funds is a good option to park your surplus money lying in the savings bank account. Thus, these funds are appropriate for investors who:
- Have a short-term investment goal
- Have a low tolerance for volatility
- Are looking to diversify with a more conservative investment
- Need the investment to be extremely liquid
Money Market Mutual Funds: Types
Debt funds earn interest income while giving the benefit of capital appreciation.
Debt funds are mutual funds investing in such debt instruments. They are of different kinds depending on the kind of debt instruments they invest in.
Conservative investors who want to invest for both the short-term and the medium-term investment horizons, should consider these funds.
Gilt funds invest your money in Government Bonds and Securities. Now, you can say how safe these funds are.
Gilt funds stand for safety as well as good returns. Since these funds invest in Government Bonds there is almost no risk to the investment. They help in diversifying your portfolio and earn guaranteed returns simultaneously.
3.Fixed Maturity Plans
Fixed Maturity Plans are closed-ended debt funds. They have a maturity period which can range from one month all the way up to five years.
These funds invest your money in safe securities like certificates of deposits, ‘AAA’ rated corporate bonds, commercial paper, money market instruments and even bank FDs.
Therefore, these funds are highly suitable for risk-averse investors. It is suitable for those investors who want to meet certain financial goals. Retired people wanting flexible and regular returns can consider investing in this mutual fund.
Considerations as an Investor
Tough the overall risk of these funds is low, they suffer from interest rate risk, credit risk and reinvestment risk.
In interest rate risk, the prices of underlying asset increase as interest rates decline and decrease as interest rates rise.
It has been established above that Money Market Fund might give you more return than a savings account.
However, investors should know that the Net Asset Value (NAV) of these funds fluctuates with changes in overall interest rate regime.
As a result, a fall in interest rates may increase the prices of an underlying asset and deliver good returns.
Expense ratio refers to the fees charged by Money Market Funds to manage your portfolio. The costs are therefore in alignment with other similar funds.
4. Investment Horizon
Money Market Funds usually have aa very short-term investment horizon. They range from 3 months to 1 year.
If investors are looking for a medium-term horizon, then investing in other debt funds like dynamic bond funds is a better option.
5. Financial Goals
As mentioned earlier, these funds are best suited for those have a short-term investment goal.
For instance, if you have to make EMI payments or you wish to invest extra cash while maintaining liquidity, then you can invest in money market funds.
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L&T Money Market Fund has been given a 5-star rating by Groww. It has delivered consistent returns ranging from 8%-9%. The risk on the other hand is moderately low.
The fund also has an option to invest via a Systematic Investment Plan (SIP) option. The minimum SIP is as low as ₹1000 per month.
The expense ratio is very low at 0.29%. Its 1-year as well as 3-year returns have beaten the benchmark index.
Some of top investments of this fund are-
Indusind Bank Ltd. (7.8%), JM Financial Products Ltd. (7.7%), Green Infra Wind Energy Ltd. (5.9%), Tata Communication Payment Solutions Ltd. (5.3%) and Indostar Capital Finance Pvt Ltd. (5.3%).
Axis Liquid Fund has been given a 4-star rating by Groww. It has delivered consistent returns ranging from 7%-8%. The risk on the other hand is low.
The expense ratio is very low at 0.11%- one of the lowest among all the peers.
Some of top investments of this fund are-
Chennai Petroleum Corpn. Ltd. (3.3%), National Thermal Power Corp. Ltd. (3.1%), National Bank For Agriculture & Rural Development (2.8%), Rajasthan State (2.2%) and Sun Pharmaceutical Inds. Ltd. (2.0%).
Aditya Birla Sun Life Floating Rate Fund has been given a 3-star rating by Groww. It has delivered consistent returns ranging from 8%-9%. The risk on the other hand is moderately low.
The expense ratio is very low at 0.16% – one of the lowest among all the peers. Its 1-year, 3-year as well as 5-year returns have beaten the benchmark index.
The fund also has an option to invest via Systematic Investment Plan (SIP) option. The minimum SIP is as low as ₹1000 per month.
Some of top investments of this fund are-
Power Finance Corpn. Ltd. (10.6%), Shriram Transport Finance Co. Ltd. (5.8%), Kotak Mahindra Bank Ltd. (4.8%), NRSS XXIX Transmission Ltd. (4.7%) and PNB Housing Finance Ltd. (3.7%).
Money market funds invest in debt securities characterized by short maturities and minimal credit risk.
They are among the best lowest-volatility types of investment. Suitable for those who have a surplus lying in their savings bank account and want to take low-risk.
Those investors who have short-term goals such as payment of college fees, vacation, medical treatment can also invest in money market mutual funds.
It is important for all investors to understand that investing in equity asset class in general and mutual funds in particular is risky. It is advisable to do proper research and invest according to your risk appetite.
Also investing for long-term is a critical virtue. It saves us from market volatility in the short-term and prevents the potential loss from timing the market.
Disclaimer: The views expressed in this post are that of the author and not those of Groww