Money market mutual funds are highly liquid and low-risk investment options. This investment generates moderate returns, while being relatively safe. These are an ideal investment for investors, looking to park surplus funds while enjoying liquidity.
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Money Market Mutual Funds: Basics, Types, Benefits and More
How do Money Market Mutual Funds work?
The money market mutual funds are used to park surplus money for the short-term. These are debt mutual funds which have an average maturity of one year or less than a year. These funds are managed by the fund managers, who create a diversified investment portfolio, by investing in various money market instruments like repurchase agreements, commercial papers, certificate of deposits and treasury bills. The fund managers aim to generate an income for investors and this is passive investment.
Types of Money Market Instruments:
Listed below are the four types of money market instruments:
- Certificate of Deposit: A certificate of deposit or CD is a money market instrument which works just like bank fixed deposits. The rate of interest on CD is quite high and it is considered to be a safe investment. The CD has a lock-in period and the deposits cannot be withdrawn before maturity. CDs are held in the electronic form in DEMAT accounts. CDs are generally issued in higher denomination only.
- Commercial Paper: Commercial papers are unsecured short-term loans or promissory notes, which have short maturity. Commercial papers are issued by finance companies, banks and corporate houses, domestic and foreign firms that have high credit ratings. These money market instruments are issued to meet working capital needs. However, commercial papers are introduced in higher denominations only.
- Treasury Bills: Treasury bills are issued by the government to meet short term funding requirements. These are one of the safest investment options among the money market instruments, and have short-term maturities ranging from 91 days to 364 days. Treasury bills are highly liquid investments and are also safe as they are government-backed securities. The returns generated by treasury bills are less attractive than other securities, as there is no interest payment. The treasury bills are introduced at a discounted rate and are redeemed at face value during maturity.
- Repurchase Agreements: A repurchase agreement is a contract between two parties or a buyer and a seller. A repurchase agreement promises payment at a future date, where the seller agrees to buy back the securities, by paying the principal along with an interest. Hence, repurchase agreements are a type of loan and the securities are the collateral, pledged to avail the loan. The rate of interest paid to buy back the securities is known as “repo rate”.
See Also: Different Types of Mutual Funds
Who Should Invest in Money Market Mutual Funds?
Investors with short-term financial goals can choose to invest in money market mutual funds. These money market instruments have short-term maturity which is below a year. So, investors can park their surplus money in these funds, to generate better returns than savings bank accounts. Money market mutual funds are an ideal investment for investors who are looking for safe and low-risk Investment Avenues.
Things to Consider as an Investor:
- Risk: As an investor, you must consider investing in these funds, after evaluating the various risks involved. The money market mutual funds involve risks like interest rate risk, credit risk and reinvestment risk. Discuss with the fund manager and choose your investment accordingly.
- Return: Money market instruments generally give higher returns than savings bank accounts. These are low-risk investments, but they do entail risk. Liquids funds are not as safe as FDs.
- Cost: An investor must pay a certain amount of fee to the fund manager to manage the investment portfolio known as the expense ratio. Before investing in any money market fund, an investor must also compare the expense ratios. By doing so, you can earn higher returns, if expense ratios are low.
- Investment Horizon: Money market mutual funds are ideal investment options for investors who want to park their funds for a very short time period i.e. 3 months to a year. So, investors who want capital protection along with short term investments can invest in money market securities.
- Financial Goals: Money market mutual funds are highly liquid. If as an investor you want to invest your surplus funds by maintaining liquidity, then money market funds are an ideal option.
See Also: How Mutual Funds Work?
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