Investors with a lower risk tolerance are always on the lookout for investment options which can offer them good returns while maintaining liquidity of their funds. Several debt funds have been designed keeping this aspect in mind. Also, most investors tend to compare the returns on their debt fund investments with bank deposits. When it comes to short-term debt investing, Money Market Funds have been a preferred option among such investors. Here, we will explore and talk about the different types of money market funds in India along with their benefits and a lot more.
What are Money Market Funds?
Money Market Funds are short-term debt funds. They invest in various money market instruments and endeavor to offer good returns over a period of up to one year while maintaining high levels of liquidity. The average maturity of a Money Market Fund is one year.
Types of Money Market Instruments
Money Market is an exchange where the trade of cash and cash-equivalent instruments takes place. The instruments that are traded in the money markets have maturities which can vary from overnight to one year. Here are some key money market instruments in India:
Treasury Bills or T-Bills
The Government of India issues treasury bills to raise funds for a period of up to 365 days. Since these are issued by the government, they are considered to be very safe. However, lower risks also translate into lower returns which is the case with treasury bills too. The returns on T-bills is lower than other money market instruments.
Certificate of Deposit or CD
A CD is a term deposit which is offered by scheduled commercial banks which does not have the option of premature redemption. The primary difference between a CD and FD is that CDs are freely negotiable.
Repurchase Agreements or Repos
A repurchase agreement is made between a bank and RBI to facilitate short-term loans. It can also be made between two banks.
Commercial Paper or CP
Companies and financial institutions with a high credit rating can issue a commercial paper which is a short-term, unsecured promissory note. It allows such entities to diversify their short-term borrowing sources. CPs are usually issued at a discounted rate while the redemption is done on face value. The investor earns the difference.
How do Money Market Funds work?
A money market fund invests in money market instruments with an objective of offering good returns (interest income) and keeping the NAV fluctuations minimal.
Based on the performance over the last five years, here are the best money market funds in India:
Note: Remember, this is not a recommendation but a list of well-performing money market funds in India. Ensure that you follow your investment plan before investing.
Who should invest in a Money Market Fund?
Since these schemes invest in money market instruments, they are ideal for investors with lower risk tolerance and an investment horizon of up to one year. Typically, investors with idle cash lying in their savings account can earn better returns by investing in these funds. It is important to note that these funds are recommended to investors having short-term cash surplus which they won’t need urgently.
Factors to consider before investing in Money Market Funds in India
Here are some important aspects that you must consider before investing in money market funds in India:
Risks and Returns
Money Market Funds are debt funds and hence carry all the risks applicable to debt funds like interest rate risk and credit risk. Additionally, the fund manager might invest in instruments with a slightly higher risk component to increase returns. Usually, money market funds tend to offer better returns than a regular savings account. The Net Asset Value or NAV of these funds changes with a change in the interest rate regime.
Since the returns are not very high, the expense ratio plays an important role in determining your earnings from a money market fund.
‘Expense Ratio is a small percentage of the total assets of the fund charged by the fund house towards fund management services.’
Ideally, you should look for funds with a lower expense ratio to maximize your returns.
Invest according to your Investment Plan
Usually, money market funds are recommended to investors with an investment horizon of 90-365 days. These schemes can help you diversify your portfolio and help invest surplus cash while maintaining liquidity. Ensure that you invest according to your investment plan.
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In the case of Money Market Funds, the taxation rules are as follows:
Capital Gains Tax
If you hold the units of the scheme for a period of up to three years, then the capital gains earned by you are called short-term capital gains or STCG. STCG is added to your taxable income and taxed as per the applicable income tax slab.
If you hold the units of the scheme for more than three years, then the capital gains earned by you are called long-term capital gains or LTCG. LTCG is taxed at 20% with indexation benefits.