Everything You Need to Know About Money Market Funds

Vijay Kuppa
Vijay Kuppa
vijay@orowealth.com
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Mutual funds are the go-to option for long-term investors; but what if you need to invest money for a short-term and still need a decent rate of return? The answer is money market funds. Money market funds are one of the best solutions for investors who want to invest their money for less than a year in a steady market.

In this article, we shall see everything you need to know about money market funds, from the types to the portfolios you can invest in. Let’s begin.

A Brief Introduction to Money Market Funds

A money market fund is a short-term investment, where the portfolio is selected to earn interest for the investors while maintaining a Net Asset Value of Rs.1 per share. The idea is to help investors have a safe option for short-term investments that are easily accessible. Quite like having your money in a savings bank account, but with a higher rate of return.

Money market fund portfolios are generally made up of liquid assets, such as treasury bills, repurchase agreements, commercial paper, certificates of deposit, or bankers’ acceptances. It is important to understand that money market funds are not the same as a money market account. Money market funds are not insured and are usually sponsored by fund companies. Why is this important? To understand that money market funds are not completely risk-free. However, as their advantages considerably outweigh their cons, money market funds are considered a good option for short-term investment.

money market funds

Types of Money Market Funds

There are four main types of money market funds, as mentioned previously – treasury bills, repurchase agreements, commercial paper, and certificates of deposit. Let us understand each of these in detail.

• Treasury Bills

A treasury bill is a zero-risk investment, issued by the Central Government. Treasury bills have different maturity periods, varying from three months to 364 days. They are sold via auctions at the end of the investment period and the interest earned by the investor is the additional selling price over the purchase price. Given that these are government-controlled investments, the rate of return on treasury bills is not as attractive as that on other money market fund investments.

• Repurchase Agreements

When a dealer sells government securities to investors and buys them back on the same day, it is known as a repurchase agreement. These are short-term agreements used to raise capital.

• Commercial Paper

Commercial paper or promissory notes are issued by companies having a high credit score. They are usually bought at a discounted rate by investors and then sold at face value. The difference is the amount earned by the investor.

• Certificate of Deposit

Certificates of Deposit are time-bound deposits offered by scheduled commercial banks. Like fixed deposits, they have a definite rate of interest, but cannot be withdrawn before the duration of expiry is complete.

• Bankers’ Acceptance

Bankers’ Acceptance is a promissory document issued by a commercial bank, offering future payment. The duration of investment ranges between one to six months and the document carries the details of repayment terms.
Benefits of Money Market Funds

Benefits of Investing in Money Market Funds

There are several benefits of investing in money market funds. The security of investment despite the shorter time-frame makes it an attractive option for investors. Here are a few of the advantages of investing in money market funds:

• Safety and High Rate of Return

The primary benefit of money market funds over other short-term investment options is that they are relatively much safer than, say, shares or equity investments. In addition, money market investments have a decent rate of return for the duration of investment, which another advantage.

• Liquid Investment

Money market funds are liquid investments that give regular dividends along with easy access to the principal amount of investment. The liquidity of the market allows investors to take advantage of the increasing rate of return in the short term and choose an appropriate money market fund accordingly.

• Investment Flexibility

Money market funds offer greater flexibility in terms of investment as they can be issued and withdrawn in short durations. A knowledgeable investor can keep track of the money market and invest in funds accordingly to obtain maximum return on investment.

These are some of the advantages of investing in money market funds. Let us now see the top money market funds in India.

Top Money Market Funds in India

FundNAV (INR)*Net Assets (Cr.)1 mo (%)3 mo (%)1 yr (%)
Aditya Birla Sun Life Money Manager Fund (Growth)240.46,9050.591.937.29
UTI Money Market Fund (Growth)4803.472,9510.581.927.18
ICICI Prudential Money Market Fund (Growth)248.8036,3040.531.847.09
Kotak Money Market Scheme (Growth)2953.5935,6150.561.857.08
L&T Money Market Fund (Growth)17.781,3530.491.736.79

*NAV as on October 9 2018

Performance of Money Market Funds in India

We have seen the advantages of investing in money market funds, as well as the top funds in which you can consider investing. However, before investing, you should be aware of all the parameters that make a good investment option.
How do you choose which money market fund is right for you? Here are some aspects you need to check:

• Asset Composition

Money market funds can comprise of a mixed portfolio, made up of a variety of assets. The right mixture of money market instruments helps you or the fund manager to create a strong investment strategy and obtain maximum profit from the investment.

• Maturity Profile of the Portfolio

The maturity profile shows the maturity duration of all the holdings in the portfolio. Analysing the maturity profile is useful in assessing the risk involved based on the diversification of capital into the various money market instruments.

• Credit Quality

The fund you decide to invest in should be of high credit quality, which is judged by its credit rating. The credit quality of the money market instrument implies how trustworthy is the security.

• Rate of Return

Before you invest in any fund portfolio check the rate of return offered by it, over the past few years. A higher rate of return is obviously preferred.

• Scheme Track Record

It is important to study the trends of money market fund portfolios to choose the appropriate mix of securities for higher returns. Check the track record of the fund over time to analyse how consistently it has been performing.

How to Invest in Money Market Funds?

Investing in money market funds is easy and straightforward. Now that we have covered the basics about money market funds, let us see how can you actually invest in them.

Here is a step-by-step procedure to guide you through the process.

• Step 1: Study the different types of money market funds

The first step is to do some research about the various types of money market funds. Study the pros and cons of each type of security, such as treasury bills, tax-exempt bonds, etc. Weigh in the advantages and disadvantages of government-securities versus private-securities and start curating your portfolio.

• Step 2: Shortlist the fund that aligns with your investment goals

Recall the financial goals you set when you decided to invest in money market funds. If you are in the dark about how to set financial goals, you can always ask a financial advisor to help you out with the same. Now, study your fund options to check whether they fulfil these investment goals. Shortlist the fund that best matches your yield expectations, is within your investment horizon and fits your risk-appetite.

• Step 3: Analyse the past performance of the scheme

After shortlisting the fund options, compare fund performances to choose the best fund. You can find this information online, along with detailed comparisons of peer portfolios, which help you make an informed decision.

• Step 4: Buy a money market fund

Money market funds can be purchased online or through a financial broker. Be sure to consult a recommended financial advisor while making the purchase. If you are planning to invest independently, there are several trusted sites online that allow you to invest in the fund and manage it yourself.

• Step 5: Track the investment

Short-term investments need regular tracking and updates. Unlike long-term mutual funds investment, you cannot afford to become complacent about your capital because the duration of investment is much shorter here. Keep track of all deadlines and expiry dates to avail maximum returns from your money market investment.

• Step 6: Consider your investment during the taxation

Money market funds can be taxable or non-taxable, depending on whether they are government securities or private securities. Make sure you check which securities are taxable while investing in them.

Taxation of Money Market Funds

Investing in debt funds earns you capital dividends, which are taxable. This short-term capital gain is added as an income source to your regular taxable income and taxes are charged accordingly, as per your tax slab.

For long-term capital gains, i.e. gains from investments over 3 years, taxes are at the rate of 20% with indexation benefits and 10% without indexation benefits. The advantage of indexation is that the cost of investment and return is adjusted for the rate of inflation, which makes the taxable amount negligible or negative.

Endnote

Money market funds are a good investment option for investors who are looking for a safe investment for a short duration. The flexibility of money market fund schemes as well as the high rate of return are two advantages that make liquid funds attractive. However, the timing of investment and the right mix of securities is important to avoid losses on the capital amount of investment.

What are your thoughts on investing in money market funds? Any other information you need before investment? Feel free to drop a comment and let us know!

Vijay Kuppa
Vijay Kuppa
vijay@orowealth.com

Vijay co-founded ORO Wealth after 6 years of investment experience in equity and fixed-income markets and was managing a $1.5 bn investment portfolio focused on Indian markets in his previous role at L&T’s Treasury. He has an MBA from IIM Ahmedabad and a degree in Chemical Engineering from IIT Bombay.

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