Money Market Funds: Features, Benefits & Why They Matter

When it comes to finding a balance between safety, liquidity, and returns, money market funds stand out as one of the best options for investors. But what do you mean by money market funds? This blog will discuss what is a money market fund, its features, benefits, associated risks, and why money market investments could be a valuable addition to your portfolio.

What is a Money Market Fund?

A money market fund is a type of fund that invests in short-term, high-quality securities like Treasury bills, certificates of deposit, and commercial paper. Money Market Funds are one of the safest investment options in India. MMFs are a low-risk method of maintaining principal and having moderate returns. Money Market Fund (MMF) funds focus on the preservation of capital, liquidity, and a modest return in the short term.

Key Features of Money Market Funds

1. Low Risk

   Money market investments focus on high-quality securities with short maturities. This ensures that the MMFs are low-risk and suitable for risk-averse investors who seek the preservation of their invested capital.

2. Regulation and Compliance

   In India, SEBI regulates the money market funds. The regulations are so strict that they have to adhere to stringent norms. This only adds to transparency and investors' confidence.

3. Liquidity

   One of the most striking characteristics of MMFs is their liquidity. Investors may quickly get back their invested money, which also makes money market funds perfect for emergency savings or short-term purposes.

4. Moderate Returns

   Money market funds usually provide higher returns than savings accounts, though not as much as stocks. There is a balance between risk and reward; therefore, they appeal to risk-averse investors.

5. Liquidity

   Money market investments are open-ended. This means that one can invest in or redeem the units at any time. Be it through a lump sum or Systematic Investment Plan (SIP) as low as Rs. 500, MMFs offer unparalleled flexibility.

6. Short Investment Horizon

   These funds are designed to be invested for the short term, from a couple of months to a year. This factor makes it ideal for the parking of idle funds.

7. Professional Management

   Run by expert fund managers, MMFs get professional strategies aimed at bringing in the best possible results. Therefore, there is no need to manage one's portfolio as an investor.

Advantages of Investing in Money market funds

1. Preservation of Capital

   The objective of MMFs is to preserve the investor's principal. They are perfect for conservative investors. These funds invest in quality, short-term securities with the aim of maintaining a stable value for the principal amount. Therefore, for people who value stability over yield, MMFs provide the comfort of knowing that neither the principal nor income is subjected to fluctuations in market prices or credit risks.

2. Diversification

   Money market funds invest in a variety of things - short-term treasury bills, commercial papers, and certificates of deposit. By doing this, you reduce the chance of defaulting on a single issuer, as you aren't exposing yourself too much to one entity. In addition, diversification adds insurance, so an investor's portfolio can withstand the ups and downs of financial markets.

3. Emergency Fund Solution

   MMFs have immense liquidity, which makes them the smart selection for an emergency fund. They offer investors quick liquidity, usually one business day, and therefore offer immediate access to cash for unforeseen costs. Whether it's a medical emergency or an urgent repair, MMFs make sure that your finances are prepared to handle unforeseen events with the least hassle possible.

4. Better Returns than Savings Accounts

   Even though money market investments can't offer the high yields of equity investments, they usually do provide better returns than you would expect from a savings account. This makes them appealing to an investor seeking higher returns on otherwise idle cash with very low risk. Safety and low returns make MMFs the practical investment alternative for those unwilling to invest in riskier assets.

5. Tax Efficiency

   There are many benefits associated with money market funds due to the tax benefits. For example, the gains from MMFs held beyond a certain duration are subjected to favourable tax treatments like reduced capital gains tax rates. Moreover, dividends accruing from this investment are a relatively tax-efficient way of generating income when considered at an investor's slab. Combining the above-listed benefits makes MMFs a financially prudent option for tax-conscious investors.

Risks Associated with Money Market Funds

While money market investments are considered to be pretty safe, they are not free from risk. Some of the risks include the following:

• Interest Rate Risk

  Money market performance is very dependent on interest rates in effect. When interest rates increase, the value of older lower-yielding securities tends to drop, hurting the returns of the fund. On the other hand, when interest rates decrease, returns from new investments might also decrease, thus making MMFs very susceptible to interest rate changes and unstable marketing environments.

• Inflation Risk

  Inflation may erode the real value of investments in MMFs. Besides, because the money is invested in predominantly fixed return instruments (T-bills, CDs, etc.), our returns will not match the growth in inflation. Your capital may even deteriorate in value over time due to the effect of high inflation.

• Credit Risk

  Although MMFs invest in high-quality, short-term securities, there is always the risk of default by issuers in the fund's portfolio. If an issuer fails to meet its obligations, it could have a negative effect on the NAV of the fund. Defaults are rare but not impossible, especially during periods of economic stress.

• Reinvestment Risk

  Given the short-term nature of the securities in MMFs, fund managers have to reinvest the returns on maturing securities frequently. If, during this period, the interest rates fall, the fund may earn lower returns on the reinvested capital.

• Market Liquidity Risk

  Under extreme market conditions, the underlying securities of an MMF would lose liquidity and fund managers would encounter severe difficulties in trying to sell assets at good prices. This might temporarily affect the fund's ability to maintain liquidity for investors.

Factors to Consider When Choosing the Right Money Market Fund

There are a number of aspects that you should consider when choosing the right MMF for you:

• Investment Objective: Make sure that their financial goals match yours and your investment objective. Do you want capital preservation and liquidity, or do you care about getting a certain return?
• Fund Performance: Take a look at the fund's past performance. But, of course, remember that good performance in the past does not mean good performance in the future as well.
• Expense Ratio: A lower expense ratio means more of your money is working for you. Look at the expense ratios of different funds and identify which one has the lowest ratio.
• Credit Quality of Investments: Check the credit rating of the securities in the fund's portfolio. Higher-rated securities are generally safer.
• Liquidity Needs: Choose a fund that matches your liquidity requirements. Some funds may offer instant redemption facilities for added convenience.

Taxation Process of Money Market Funds

Taxation, in any investment, contributes immensely to its overall returns. Here are some ways through which money market funds are taxed:

1. Short-Term Capital Gains (STCG)

   When you sell the units of an MMF before three years from the date of investment, the returns are considered to be a short-term capital gain. This is taxed at your applicable income tax slab rate.

2. Long-Term Capital Gains (LTCG)

   For units held for more than three years, gains were earlier taxed at 20% with indexation benefits. Gains on units purchased on or after April 1, 2023, shall now be taxed at your slab rate for long-term gains.

3. Dividend Income

   Fund dividends are taxable and will be included in your taxable income as "Income from Other Sources" and taxed at your slab rate. Before, dividends were not taxed, but now they go in with your taxable income.

4. Tax Deduction at Source (TDS)

   TDS may be applicable on dividends or gains of MMFs. Please consult a tax advisor to know the exact implications of your investment.

Tips to Invest in Money Market Funds

If you've been considering Money Market Funds as part of your financial journey, then kudos to you for taking one more step toward a smart and safe investment. Here are some practical tips to make the most out of these low-risk investment alternatives:

1. Define your goals

   Think about what you want to accomplish first. What do you want to do with all your extra money? You are looking for a short-term parking spot. Or maybe a liquid emergency fund? Identifying your desired outcome can guide you to the right money market fund.

2. Consider the Fund's Holdings

   Not all money market funds are created equal. Some may have a greater emphasis on government securities, such as treasury bills, while others may include corporate papers or certificates of deposit. Always check the fund's portfolio to make sure it meets your risk tolerance. If safety is your primary concern, then look for funds with a higher percentage allocated to government-backed instruments.

3. Expense Ratios Comparison

   When you look at the investment, the expense ratio is something that will have a large impact on your end returns. This is the fee that the fund house charges for managing the fund. It can mean better net returns for you, so it's always worth comparing this across MMFs before choosing one.

4. Check Liquidity Terms

   One of the best things about MMFs is that they offer liquidity, but you do have to get into the nitty-gritty details. Most allow for easy withdrawal, although some will have restrictions or even exit loads in case you redeem too soon. Just ensure you choose a fund whose liquidity terms would be appropriate for your needs.

5. Research the Past Performance

   While past performance is no guarantee of future returns, looking at this can give you some idea as to how the fund has performed under different market conditions. A consistent track record of moderate returns is normally a positive indicator.

6. Know the Risks

   Though MMFs are considered one of the safest investment plans, they do not completely eliminate the risk. You'll have to bear risks like interest rate changes or even credit defaults. Knowing these risks will help you invest with the right expectations.

7. Start Small if You're New

   If you're a new investor, start with low amounts. Most money market funds let you get started with as low as ₹500 through a Systematic Investment Plan. This way, you get to dip your toes without putting too much at stake.

If you're looking for a low-risk, liquid, and professionally managed investment option, money market funds are worth considering. With features like high liquidity, safety, and tax benefits, MMFs can cater to a wide range of financial goals.

Take a small step, watch the performance, and align your investments to your goals. To create a holistic approach to financial planning, you combine money market investments with other products like Savings Plans, Investment Plans, or even an Endowment Policy that helps build a well-rounded portfolio.

Ready to secure your financial future? At PNB MetLife, we're committed to helping you make informed financial decisions. Explore our range of investment plans and take the first step toward a financially secure future.

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