Know Everything About Money Market Mutual Funds?

Money Market Mutual Funds (MMMF) are schemes that invest in short term debt instruments, cash and cash equivalents that are of high quality. Because of this, money market mutual funds are considered as high quality instruments with low risk. They have a predictable return rate.

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What are Money Market Mutual Funds?

How Does It Work?

The fund manager invests in high quality debt instruments of short term maturity under a year. These instruments earn interest, improving returns. MMMF reduces fluctuations in the net asset value (NAV) of the fund.

See Also: The Advantages of Money Market Funds

Types of Money Market Instruments

The most common types of money market instruments are:

• Commercial Paper (CPs): Short term instruments issued by companies or financial institutions to meet their short term liabilities (accounts payable, managing inventories). They are unsecured instruments also known as promissory notes. They are issued at discount rate from face value and redeemed at face value.
• Certificate of deposit (CD): This instrument offers interest in exchange for a lump sum deposit for a specific period of time. This is offered by most commercial banks.
• Treasury bills (T-bills): One of the safest instruments because these are backed by the government. Government issues treasury bills to finance government activities. Maximum maturity period is 365 days. Rate of return is low. Auctioned by Reserve bank of India.
• Repurchase agreements (repo): A Person typically the dealer sells government securities to an investor and agrees to buy them back the next day for a slightly higher price (repo rate). The difference in price in the gain of the investor.

See Also: What are the Instruments Purchased by a Money Market Fund?

Things to Consider Before Investing in MMF

• Risk: MMMF involves credit risk, interest rate risk, reinvestment risk. Interest rate risk means when the interest rate declines, asset price increases and vice versa. Credit risk is the borrower failing to repay the credit lent. Reinvestment risk is the inability to reinvest cash at the prevailing rate.           
• Return: MMMF offers decent returns. There is no credit risk and no interest rate risk.
• Cost: Consider the expense ratio. Expense ratio as mandated by SEBI is 1.05% by the SEBI (Securities and Exchange Board of India). Changes are applicable on this rate.
• Financial goals: if your motive is to invest extra cash while maintaining liquidity, then MMMF is considered. It encourages diversification.
• Time: These are suitable for short term investment plans. Generally extends from 3 months to one year.

Why Invest in MMMF?

Money market mutual funds are an investment option that can be considered by most people. It offers short term investment with high liquidity. It is a profitable source of income that can be earned within a limited time frame. As the fund invests in a variety of instruments, diversification of portfolio must be maintained.

MMMF offer higher returns in comparison to a regular savings account. An investor who wants to keep his money with stable and safe returns may consider MMMF as an option. However, if your objective is to invest for medium to long term plan, then MMMF is not the right option.

See Also: How Mutual Funds Work?

Emergency Funds and MMMF

Keep an amount aside to meet unexpected situations in life in an emergency fund. Uncertainty is inevitable, and it becomes worse without adequate financial back up.  To deal with this, it is important to maintain an emergency fund.

Emergency fund must be liquid. It is the most important criteria to be considered while investing for an emergency fund. It must allow you to withdraw cash without delay.

An ideal emergency fund must have at least 3 to 6 months of your salary set aside for the emergency.

You can categorize emergency funds as short term and long term, if organized financial security is your top priority.

1. Long Term Emergency Fund: Less liquidity and more returns. This is to be used in situations like a natural disaster, medical emergency or unexpected death and so on.
2. Short Term Emergency Fund: Go for this option during emergency situations. More than returns, accessibility must be the top feature of this fund.

Once you have collected enough money to serve the purpose of the emergency fund, it must be further invested. This ensures steady returns. Make sure you invest in less risky, more liquid instruments.

Money market mutual funds can be considered as a short term emergency fund option. It approves all the features to be included in a short term emergency fund. They are highly liquid. They have the additional benefit of earning high returns if the market rates are favorable.  However, the risk involved in interest rate fluctuations is to be considered.

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