Money Market Mutual Funds
Money Market Mutual Funds
Money Market Mutual Funds (MMMF) is a short-run liquid investment with high credit rating. It targets to provide the investors with a low-risk return haven to invest in easily accessible cash and cash-equivalent assets. This article discusses in detail about Money Market Mutual Funds.
Purpose of MMMF
Money Market Mutual Funds are used to manage the short-run cash needs. It is considered to be an open-ended scheme in the debt fund category that deals only with cash or cash equivalents. Since these securities have an average maturity of one year, it is termed as market instruments.
Mode of Operation
The fund manager invests in high quality, liquid instruments such as Treasury Bills (T-Bills), Repurchase Agreements (Repos), Commercial Papers and Certificate of Deposits. These funds intend to earn interest for the unitholders without leading to a decline in funds’ Net Asset Value (NAV). Money market fund can be compared with a savings account that comprises of cheque facility, the facility to redeem without lock-in period and electronic transfer of money.
Types of MMMF
There are two types of Money Market Mutual Funds namely
- Institutional Money Market Mutual Funds
- Retail Money Market Mutual Funds
Institutional Money Market Mutual Funds
Institutional Money Market Mutual Funds are authorised by the governments, institutional investors and businesses etc. There is a huge sum of money deposited in the institutional money funds.
Retail Money Market Mutual Funds
Retail Money Market Mutual Funds are used for depositing money temporarily. The investment portfolio of money market funds incorporates treasury bills, short term debts, tax-free bonds etc.
Types of Money Market Instruments
There are four types of money market instruments. They are
- Certificate of Deposit (CD)
- Commercial Paper (CPs)
- Treasury Bills (T-Bills)
- Repurchase Agreements (Repos)
Certificate of Deposit (CD)
Certificate Deposits are similar to time deposits like fixed deposits that are offered by scheduled commercial banks. The only dissimilarity between Fixed Deposit and Certificate of Deposit is that an individual is unable to withdraw Certificate of Deposit before its expiry.
Commercial Paper (CPs)
Commercial Papers are issued by companies and other financial institutions that have a high credit rating. This is also called as Promissory notes. The papers are issued at the discounted rate and redeemed at face value. The difference is the return that is earned by the investor.
Treasury Bills (T-Bills)
T-Bills are issued by the Indian Government to raise money for a short term of up to one year. This is considered to be the safest instruments as it is backed by a guarantee of government. The rate of return, also known as risk-free rate, is low on T-Bills when compared to other instruments.
Repurchase Agreements (Repos)
Repurchase Agreements is an agreement by which RBI lends money to commercial banks. These agreements involve both the sale and purchase of agreement simultaneously.
Applicability of MMMF
Money market funds aim to provide the highest degree of short-term income by maintaining a well-diversified portfolio of money market instruments. Investors who have a short-term investment horizon of one year can invest in this fund.
The investors with excess cash in a savings bank account and low-risk appetite can invest in money market funds. These funds give a higher return than the savings bank account. The investors include both corporate and retail investors.
Features of MMMF
- Money market mutual funds are observed to be one of the safest instruments of investment for the retail low-income investor. The assets belonging to a money market fund are invested in safe and stable instruments of investment that are issued by governments, banks, corporations, etc.
- Money market instruments require a huge sum of investments and it is beyond the capability of an ordinary retail investor to make investments in such large sums.
- Money Market Mutual Funds provide retail investors with an opportunity to invest in a money market instrument and to benefit from the price advantage.
Merits of MMMF
Given below are the advantages that can be obtained by investing in a Money Market Mutual Fund.
- Securities in the money market face low risks.
- Money market funds are the safest and the most secure of all mutual Funds investments.
- It is one of the least volatile types of all mutual fund investment.
- Investing in a money market account is very simple. Mutual funds investors can open an account, deposit money and make withdrawals virtually at their convenience.
- The performances made by a money market funds is closely related to the interest rates that are laid by the Reserve Bank of India and the Central Bank of India. Therefore, when RBI raises the rates in the market, yields increase and money market funds assures to give good returns.
Factors for Consideration for an Investor
Risk: These funds face interest rate risk, credit risk and reinvestment risk. In interest rate risk, the prices of the underlying assets increase as interest rates decline and decrease as the interest rates rise. The fund manager invests in risky securities that have a higher probability of default to deliver higher returns.
Return: A Money Market Fund gives more return than a savings account. However, there are no guarantees returns. The Net Asset Value (NAV) varies with the changes in an overall interest rate regime. A fall in interest rates increases the price of the assets and delivers good returns.
Costs: Expense ratio denotes the fees that are charged by the Money Market Funds to manage an individual’s portfolio. SEBI had prescribed the maximum limit as 2.25%. An ideal fund is the one that keeps the expense ratio at the lower levels. As the assets under management (AUM) increases, the scheme reduces the cost of operations.
Investment Horizon: Money Market Funds are acceptable for very short-term investment horizons which could be from three months to one year. For medium-term horizons, an individual is required to invest in dynamic bond funds.
Financial Goals: If an individual needs to make EMI payments or invest additional cash during maintaining liquidity, money market funds come in handy. A small portion of the portfolio can be invested for diversification.
Tax on Gains: Investing in debt funds offers capital gains that are liable for taxation. The tax rates depend on the holding period, that is the duration an individual is invested in the fund. A Short-Term Capital Gain (STCG) is made for a period lesser than three months.
Long-term Capital Gains (LTCG) is made when an individual has invested for more than three years. STCG from money market funds are added to the income and taxed accordingly to the income slab. LTCG from money market funds is taxed at the rate of % after indexation and % without the benefit of indexation.
Know more about Income Tax on Mutual Funds