All you need to know about money market mutual funds
The majority of people in India like to grow their savings or excess money in more safe and risk-free investments like fixed deposits or recurring deposits. Increasing awareness of the stock market has now made people more open to investing in these options. Money market mutual funds are a safe bet for people who are interested in the stock market and want to invest without worrying about the risks that are typically involved in the stock market.
Money market mutual funds give a perfect combination of factors such as liquidity when you need it, decent returns, and high levels of safety. They are perfect to park your savings safely and use it when needed for any planned or unplanned events, such as vacations or hospital emergencies. It is also a great option to balance out your portfolio with safe instruments that protect your capital, especially if the rest of your portfolio is filled with high-risk mutual funds. Read more details about money market funds here.
What is a money market mutual fund?
Money market mutual funds are open-ended schemes with a maturity period that is typically less than a year. The investments are made in instruments that are highly liquid, low in risk, safe, and high in quality, such as repurchase agreements, certificate of deposits, commercial paper, treasury bills, etc. The interest rates for such funds will be floating, fixed, or changeable.
There are also short-term money market instruments that have a maturity period as short as 3 months. This is perfect for emergency funds where you can park your money while making it grow even if it is for a period of 1-3 months. This is ideal for those situations where you foresee the need for money in the near future and want it to grow just a little bit more.
Whether it is to pay for your child’s education abroad or for a wedding in the family, a vacation you have been dreaming of, or a surgery/treatment/cosmetic procedure that you have scheduled in 3 months, you can be sure that your money will be in safe hands and be returned to you a lot more than what you had put in. Those who are on the verge of retiring can also transfer funds to liquid funds that are less risky from their equity schemes using the Systematic Transfer Plan (STP) feature that is available in many mutual fund schemes.
What are the different kinds of money market mutual funds?
There are different types of assets that money market mutual funds invest in. There are basically two types: institutional money market mutual funds and retail money market mutual funds. The former is held by the government, businesses, and institutional investors. The latter consists of tax-free bonds, treasury bills, and short-term debts.
Money market mutual funds are typically gilt funds, debt funds, and fixed maturity plans (FMPs).
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Gilt funds invest in government securities, bonds, and loans of the state government and central government loans which are medium to long term. There is no risk at all to the investment and returns are assured and decent. It helps in diversification of portfolios. The Reserve Bank of India lends money to the government and issues government securities in return for the loan. The fund manager of the gilt fund subscribes to these government securities which have a specific tenure. When they mature, the gilt fund receives money on the return of the government securities. The returns from a gilt fund are dependent on the interest rates. The best time to invest in gilt funds would be when the interest rates are falling. They can generate up to 12% in returns.
Debt funds are for earning capital appreciation with interest income. The duration and interest are pre-decided. Another name for them is ‘fixed income securities’ because you know beforehand what and how much you are getting out of it. Investments are made in different types of securities, so there is diversification, which gives good returns, but there is no guarantee of returns even if they are within a range that is predictable. The investments are made in securities that have good credit ratings. So, the manager of a debt fund will only invest in those securities which have high credit scores and no defaults in payments.
When the interest rates are falling, the manager will most likely invest in long-term securities and vice versa. So, this is a good deal for those investors who are looking not just for short-term investments, but more medium-term investments too. The range could be anywhere from 3 months to 5 years. There are investments which offer a Monthly Income Plan as well, which is ideal for those who want a regular income. Short-term investments are made in liquid funds while medium-term investments are made in dynamic bond funds which offer higher rates of interest when compared to fixed deposits.
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Fixed maturity plans (FMPs):
Fixed maturity plans are mutual fund schemes that are close-ended with a pre-defined tenure period that can be anywhere from 30 days to 5 years in duration. The investments are made in bonds, certificates of deposits, government securities, or company debt, which are fixed income instruments.
They do not have an equity component unless it is a plan that has opted for a limited equity component. This is ideal for people who want safe, regular, and flexible returns. It is also good as a tax saving instrument for those in the higher-income tax bracket. Although the interest rates on FMPs are similar to that of fixed deposits, they attract lower taxes because of the indexation benefit on long-term capital gains.
There are 5 components you need to look into before you invest in money market mutual funds. These are:
- Maturity profile: Maturity of holdings in the portfolio of the fund.
- Credit quality: Credit ratings of the securities that the fund invests in. The higher the credit rating, the better the returns.
- Asset composition: Knowing the kind of assets that are being invested in.
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