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What are Money Market Funds? Money Market Funds are kinds of Mutual Funds with a short duration of maturity. Learn from this Money Market Fund Investment Guide how every investor can make a suitable choice of investing in a Money Market Fund.
What are Money Market Funds
As the term suggests, Money Market Funds are a kind of Mutual Funds that invest in money market instruments. Money market instruments are highly liquid securities with a maturity of up to one year. These comprise fixed-interest-bearing securities which are issued by borrowers to meet short-term fund requirements. For example, the Reserve Bank of India issues treasury bonds for a term of 365 days or less as a measure of controlling inflation in the economy.
These are one of the most popular forms of Debt Funds and are preferred by investors looking for options quickly convertible into cash with minimal risk. Since the funds are invested into fixed-interest-bearing money market instruments, the returns on these securities are, often, predictable and equal to the interest on underlying securities, subject to conditions.
How do Money Market Mutual Funds Work
These funds function in a manner similar to other Mutual Funds. The funds collected from investors are placed into various securities having maturities of up to one year. Any interest collected by the fund from these securities is, either, distributed as a dividend on the units held by the investors or retained by the fund, which, in turn, increases the Net Assets Value (NAV) of the fund.
The portfolio of investments on these funds comprise securities like Certificates of Deposits, Commercial Paper, Treasury Bills, and Short-Term Bonds. All these are high credit-rated securities, issued by government agencies or other private players with strong credentials. Thus, the investors need not worry about credit risks and can enjoy higher interest rates on their investments, as compared to the market.
Most of the time, the interest received by the fund is distributed as it is to the investors and thus, these funds are less advantageous from the point of view of capital appreciations since interest received is not used to make further investments. These are, generally, treated as an alternative for cash investments, with a slightly higher rate of interest than fixed deposits with banks.
Types of Money Market Instruments
Money Market Funds invest in Commercial Papers, Treasury Bills, Certificates of Deposit, and Repurchase Agreements.
- Certificates of Deposits (CD) are similar to a bank’s fixed deposits and are offered by commercial banks. The difference between the two is that CDs are locked until their maturity period and can be traded, unlike general fixed deposits.
- Treasury Bills (T-Bills) are considered to be one of the safest instruments of investment as they are issued by the Government of India to raise funds for a period of 1 year.
- Commercial Papers (CPs) are also known as promissory notes. They are issued by financial institutions and companies that have a high credit rating. These instruments are issued at a discounted rate and redeemed at their face value as they are unsecured instruments.
- Repurchase Agreement (Repo) is when a dealer sells securities then buys them back a short time later or at a pre-specified price. The difference between the re-purchase and sale prices represents the implicit interest paid for the agreement. This is usually done only for Government securities.
Who Should Invest in Money Market Funds
Money Market Mutual Funds advantages are manifold. They are ideal for investors who are looking for secure alternatives to fixed deposits and other liquid holdings for a shorter duration of time, particularly, between 6 months to one year.
If the investment horizon exceeds one year, then, these funds may not be an ideal choice as they offer very minimal capital gains, and thus, investors stand a chance to lose on returns. For senior citizens and other investors having a low-risk appetite, these funds may prove to be fruitful as they are highly secured, especially, when compared with equity-oriented funds.
Money Market Fund Taxation
If the investor chooses to sell his investment within 3 years of purchase, he is liable to pay short-term capital gain tax. The tax percentage depends on the income tax slab of the investor.
If the holding period is more than 3 years, all the profits will attract long-term capital gain tax. However, investors can take the benefit of indexation. Post calculating the benefits and deducting the same from the profits, investors will have to pay 20% on the remaining amount.
Things to Consider as an Investor
All the investors should strictly keep in mind the following factors before considering Money Market Funds as an investment option:
- Risk: Credit risk refers to safety of funds invested and probability of any default, in return. Thus, Money Market Funds are, quite, secure and offers low risk due to short duration and high credit-worthiness of the securities invested in.
- Return: It is a well-acknowledged principal that risk is directly proportional to return. Thus, since the Money Market Funds offer low risk, their return is also low as compared to other funds. However, they still offer a higher return when compared with other possible investment avenues having same duration and risk.
- Investment Horizon: Time factor is important because Money Market Funds perform better only in small duration of time, particularly, less than one year. This is because they invest in debt securities having maturities of less than a year.
- Tax: Any return from Money Market Funds will be taxable in the hands of the investor. Interest or dividend received from the fund is taxable as per the normal slab rates under The Income Tax Act, 1961. Capital gains from sale will be, generally, taxed depending on the time difference between the date or purchase and sale.
How to Invest in Money Market Mutual Funds
Any investor can enjoy the benefits of investing through Nivesh in the following easy steps:
- Create an account in Nivesh by providing your basic KYC details. (If you already have an account then just login into your account)
- On your portfolio page click on the Buy New tab at the right top corner of the screen.
- Select the category and choose the funds you want to purchase.
- If you already know the name of the fund to buy, then you can search the particular fund through Quick Order.
- Fill the transaction details and confirm. You can place up to 5 orders in one go.
- You can make payment through your registered account through UPI, Direct Pay, or NEFT/ RTGS , Bank Mandate or Cheque. For same-day NAV, select UPI, Direct Pay or NEFT / RTGS as other payment options may take a few days to clear, Nodal account takes about 1-2 days to clear payment from the approved mandate and cheque takes about 2-5 days in clearing due to which you will not get the same-day NAV.
Frequently Asked Questions (FAQs)
1. Is Money Market Fund a Mutual Fund?
Yes. Money Market Fund is a type of Debt Mutual Fund that invests the money in short-term fixed interest-bearing securities like Corporate Bonds and Commercial Papers.
2. Are Money Market Funds Insured by the Federal Government?
No, Money Market Funds are not insured or backed by the government. However, in the case of Government Money Market Funds, the securities in which the funds are invested may be secured or guaranteed by the Government.
3. What are the Benefits of Money Market Mutual Funds?
Money Market Mutual Funds are ideal investment funds for risk-averse investors who are looking for alternatives to traditional sources of investments like fixed deposits. The main benefit of investing in these funds is that they offer higher returns over fixed deposits while maintaining the same levels of risk and liquidity.
4. How to Invest in Money Market Funds?
Money can be invested in Money Market Funds, either, directly by subscribing to the units of the funds through their websites or through the Demat accounts.
They can also be subscribed through brokers like Nivesh.
