KNOWLEDGE CENTRE Debt Funds / What Are Money Market Funds?

What Are Money Market Funds?

Money markets provide investors with stable income and are managed to maintain a stable share price. Due to their stability, they are used for cash reserves or for the instant money needs.

Money market funds are a type of mutual funds that invest in a short term, high-quality, fixed-income securities like short-term bank certificates, treasury bills, commercials issued by corporates. The maturity period of a mutual fund’s portfolio should be 90 days or less on an average to help you protect against interest rate risk. The income which the money market funds provides is determined by short-term interest rates.

How Do Money Market Funds Work?

Let’s look at the working of a money market fund with an example. George is a recent college graduate. He wants to save up for a trip to Europe in 12 months. Since his time is short, he chose to invest in money market funds. Since they are short term, the investment is done for a limited period of time. If George needs his amount before the investment time has ended before 1 year, the money market funds has an option to sell the fund. This will provide a shorter profit to the investor.

What Are The Different Types Of Money Market Funds?

There are two main types of money market funds that one should know about:

  • Institutional Money Market Funds

These money market funds are held by the government, business, institutions etc. A huge amount of money is parked in institutional money market funds. These kinds of funds include hedge funds, pension funds, insurance companies and investment advisors. The institutional money market funds set a high initial investment amount. In order to compensate for the large investment, the fund companies charge low fees.

  • Retail Money Market Funds

These kinds of funds are used to park the money on a temporary basis. This comprises of short-term debts, treasury bills, etc. Retail money market mutual funds are open to all investors. These can be bought directly or with the help of a fund manager.

What Are The Advantages Of Money Market Funds?

Money market funds are special for three benefits they offer:

  • Low Initial Investment
  • Low Risk To Exposure
  • Higher Liquidity

Let’s look at the above points in more details:

  • Low Initial Investment

Money market funds has low requirements which are lower than a general mutual fund minimum requirements. The money market funds allows an investor to take advantage of the safety provided by these investments even if you’re investing small sums of money.

  • Low Exposure To Risks

The securities in which they are invested are generally some of the most stable and safe investments. Money market funds carry a low default risk and offer a reasonable return.

  • Higher Liquidity

Money market funds can be bought and sold at any time and carry check writing privileges. The money market funds offers the same-day settlement, unlike other fund options which take 3 days.

What Are The Risks Associated With Money Market Funds?

Before investing in money market funds one must take care of the following details:

  • Fund Expense Ratio
  • Investment Aim
  • Credit Risk

Let’s look at the above points in more details:

  • Fund Expense Ratio

The returns offered by money market funds are better than fixed deposits, but they are still on the lower side. Hence, if a fund charges at a higher than normal expense ratio, it will eat into your profits. To avoid this, you should first compare the funds that you can invest in and judge them based on their returns as well as their risk ratio.

  • Investment Aim

If you are considering money market funds for retirement option, the money market funds might not be an appropriate option. The returns on these are generally higher it might not be an adequate option. Instead, it should be used to accumulate money on a temporary basis for an anticipated expense soon.

  • Credit Risk

The money market funds are risk-free but it is not absolute. The risk of these types of funds depends upon the credit rating set by the Reserve Bank of India. Funds manager usually compensate for smaller changes, but drastic changes in credit rating can affect your returns.

If you’re not sure about which type of fund to invest in, you should try our ARQ mutual fund advisory. We understand your investment needs and recommend you the best performing mutual fund to achieve them.

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