Reading time: 6 minutes
Subscribe

Money Market Mutual Funds (MMMF) predominantly invest in high-quality short-term debt instruments, cash, and cash equivalents. They best suit investors who are risk-averse with an investment horizon of three months to one year. Though they do not guarantee returns, they offer a predictable return usually considered risk free return due to the high-quality

Money Market Funds

What are money market mutual funds?

Money market mutual funds invest in securities that have a maturity of around one year. Hence investors use it to manage short-term cash needs. The fund invests in certificate of deposits, commercial papers, treasury bills, and repurchase agreements. The investments are generally in fixed income generating securities.

This is why these securities are called money market instruments. Money market instruments are highly liquid as they come with short maturities. They are highly secured as well, as the issuers of these instruments have a strong credit rating

Types of money market securities

  1. Certificate of deposit (CD) is an instrument that allows an individual to park money in a bank for a predetermined time and rate. The amount parked in a CD cannot be withdrawn on demand, and the principal plus interest is available only upon maturity. RBI regulates the interest rates of CDs. It is a term deposit or fixed deposit being a fixed income generating instrument.
  2. Commercial Paper (CP) is an instrument that is issued by high rated companies and institutions. They are unsecured and hence give higher returns than treasury bills. They are issued at a discount and redeemed at face value at the end of the investment horizon, which is usually around one day to 270 days.
  3. Treasury bills (T-Bills) are government securities. Due to the Central Government backing, experts consider it as a risk free investment. Hence, the return on these instruments is low if we compare it with other instruments. T-Bills have varying maturity periods ranging from 91 days up to 365 days.
  4. Repurchase Agreements (Repos) enables short term borrowing and lending by sale or purchase of debt instruments. The sale happens at a fixed price, only to be purchased back at a higher price. The difference in both the prices is usually the cost of investment or the repo rate.

Who should invest in Money Market Mutual Funds?

Individuals who have surplus cash in their saving account or wish to invest in a fixed deposit. They need stable growth rates with a horizon of one year can consider money market mutual funds as an option to invest. The returns from these funds may not be guaranteed but is often predictable. The return is also higher than bank deposits, hence allowing an investor to make money from the surplus cash.

Money market mutual funds do not suit all investors. There are certain things an investor has to consider before picking these funds to park the surplus money.

Things to consider as an investor

  1. Risk: In India Money market is subject to interest rate risk, default risk, credit risk, and reinvestment risk. The interest rate might go up, and the price or asset value of the underlying security may go down or vice versa. The issuers of these securities might default on the payments. The fund manager might invest in risky securities for a higher return and asset. Hence, MMMF is not entirely risk-free.
  2. Costs: The investment in MMMF comes with a cost. The fund house charge an expenses ratio on the NAV. SEBI has capped the expense ratio for the fund house to protect the interest of investors.
  3. Investment horizon: The investment horizon for mutual funds varies with the type. MMMF is ideal for investors with a horizon of one year as the average maturity of all the securities in the fund is around one year. For investors with a horizon of more than a year can look at other debt funds
  4. Goals: It is essential to align financial goals with investments. MMMFs can be the right choice for a goal of 1 year
  5. Tax: The tax on capital gains depends on the holding period of the investment. For any investment redeemed before 36 months of investing, STCG tax is levied. STCG tax is based on the tax slab of the investor. LTCG tax is levied if the investing period exceeds 36 months, and the rate of tax is 20% after indexation.

Considering all these, an investor has to decide whether MMMF is the best fit or not.

Expenses

Typically, Money Market funds might charge an exit load if the money is withdrawn inside a week. With online access to mutual funds, small investors are taking advantage of investing in money market funds for the short term instead of holding cash in a savings bank account 

As money market funds do not earn very high returns, the expense ratio of the fund plays a very vital role in determining the earnings. Ideally, investing in lower expense ratio funds would be most efficient.

Taxation

In India Money Market instruments taxation is the same as that of debt funds. The tax rate depends on the duration for which an investor holds the investment. 

For an investment horizon of less than three years, the short term capital gains (STCG) arises. The tax on STCG is as per the applicable income tax slab of the investor. While for investments beyond three years, Long Term Capital Gains (LTCG) arises. And the applicable tax rate is 20% with indexation

Money Market Funds in India

Investing in money market instruments in India is beyond a retail investor’s reach. The minimum investment for these instruments is high. Money Market Mutual Funds allow retail investors to invest in such instruments with small investments. The experts considered it safer investments as the government, banks, and big corporations issue them.

The return from these funds, though not entirely risk-free, is predictable. Independent agencies rate money market mutual funds, making it easy for investors to pick funds. Investors with surplus money can invest in these funds for short term needs. An investor with a large amount in his saving account and looking for a less riskier investment can consider this option. No doubt there are other savings scheme as well, however money market funds have other benefits over savings scheme as well.

Published on February 10, 2020