What are Money Market Funds?

Money market funds prioritise safety and stability. Here, the focus is on short-term debt instruments, cash, and cash equivalents. These mutual funds are popular among institutional investors. If your goal is predictable returns with minimal risk, money market mutual funds may suit your portfolio. In this article, we will explore the basics of money market funds, the types of instruments they invest in, their benefits, and the key considerations for investors.

What are Money Market Funds?

Money market funds are open-ended debt funds that invest solely in high-quality liquid instruments. These instruments are typically issued by financial institutions, government entities, and corporations, and they have a maturity period of up to one year. Such money market securities are as follows:

• Treasury bills
• Commercial paper
• Repurchase agreements
• Certificates of deposit
• Government securities

By investing in these high-quality short-term debt instruments, money market funds aim to maintain a stable net asset value (NAV) while providing a safe and stable return.

How Do Money Market Funds Work?

The primary objective of money market funds is to earn interest for unitholders while maintaining the stability of the NAV. These funds focus on high-credit-rating securities, which helps minimise the risk of default and ensures that the fund’s NAV remains stable.

These funds are often considered a safer alternative to more volatile investment options, such as medium or long-term bonds. However, it's important to note that money market funds are not without risks, and they may be impacted by changes in interest rates and capital markets.

Advantages of Money Market Funds

Take a look at the list of advantages that money market funds provide you during the investment journey:

Low Risk: These funds focus on investing in safe bonds that are backed by reliable companies and sovereign bonds. This helps minimise the risk of losing money.

High Liquidity: Money market funds offer high liquidity, allowing investors to withdraw their money on any business day without penalties.

Diversification: Investing in money market funds allows for instant diversification across various money market instruments, which can help mitigate risk.

Higher Returns than Savings Accounts: While the returns from money market funds are generally modest, they can outperform traditional savings accounts, especially in a rising interest rate environment.

Who Should Invest in Money Market Funds?

Money market funds are ideal for investors, with a short investment horizon of up to one year. These funds are suitable for individuals with a low-risk appetite who want to park surplus funds in an instrument offering higher returns than a regular savings account. Both corporate and retail investors can benefit from the liquidity and stability that these funds provide.

Money market funds are also useful for commercial banks, brokerage firms, and other financial institutions that need to manage short-term cash flow or maintain liquidity for immediate cash flow needs.

Factors to Consider When Investing in Money Market Funds

Return: Money market funds usually earn more money than regular savings accounts. The value of the fund can go up or down depending on how interest rates change. When interest rates go down, the value of the things the fund invests in can go up, which means you will earn more money.

Costs: Money market mutual funds typically have a lower expense ratio compared to other types of mutual funds. The expense ratio is important to consider when looking for an investment because it directly impacts the overall return on investment.

Investment Horizon: These funds are best for investments that you only need for a short time, like three months to a year. If you need your money for a longer time, you might consider other debt funds like medium to long-term bond funds.

Financial Goals: If you need to make regular payments or want to invest extra money while keeping some of your money easily accessible, you can use money market funds. It's also a good idea to invest a small amount in these funds to spread out your investments.

Taxation on Money Market Fund Gains

Previously, the taxation of profits from money market funds was more time bound, with capital gains taxed at different rates depending on the holding period. However, the recent updates have aligned the taxation of profits from selling money market funds with the investor's income tax slab.

For example, if you are in the 30% income tax bracket, and you sell your money market fund units within a year at a profit, that profit will be taxed at 30%.

How to Invest in Money Market Funds?

To begin investing in a Money Market Fund, follow these steps:

• Open the INDmoney app and log in with your credentials.
• Navigate to the "Mutual Funds" section within the app.
• Use the filter options to select "Money Market Fund" to view the available choices.
• Decide between a lump sum investment or a Systematic Investment Plan (SIP) for regular investments.
• Enter the desired investment amount and confirm the transaction.