A Beginners Guide to Money Market Mutual Funds

Money market mutual funds are among the many types of investment options available in India. These funds are ideal for investors looking for low-risk investment options. However, even if you’re a risk-aggressive investor, you may still choose to add money market mutual funds to your portfolio for diversification. That said, here’s everything you need to know about this unique investment option.

What are Money Market Mutual Funds?

A mutual fund that invests the pooled capital from investors in money market instruments is termed a money market mutual fund. Money market instruments are essentially short-term debt instruments with maturities of up to a year. They’re highly liquid and generate moderate returns.

Some of the most popular money market instruments in India include treasury bills (T-Bills), Certificates of Deposit (CD), Commercial Paper (CP) and Repurchase Agreements (Repos). Since these instruments are issued either by the government, scheduled commercial banks or companies with high credit ratings, money market mutual funds are often considered to be low-risk investment options.

One of the major advantages of investing in money market funds is liquidity. You can quickly and effortlessly purchase and sell units of the fund. In fact, most fund houses credit the funds to your account on the same day the redemption request is placed.

How much returns can I expect in a Money Market Mutual Fund?

The returns from a money market mutual fund are dependent on two major factors - the interest rate in the market and the tenure of holding. The higher the market interest rate and the longer the tenure, the greater your returns are likely to be. The average annual returns from money market mutual funds can range anywhere from 5% to 7.5%.

Are Money Market Funds Better Than a Savings Bank Account?

The average savings bank account interest rate ranges from 2.5% per annum to 4% per annum. Compared to a money market fund, the rate of interest on savings bank accounts is considerably lower.

Therefore, if you’re looking for a low-risk and highly liquid investment option with good return generation potential, investing in a money market fund may be better than parking your funds in a savings bank account.

However, it is essential to keep in mind that money market mutual funds are not completely devoid of any risk.

Factors To Consider Before Investing in Money Market Mutual Funds

As an investor, you need to take certain factors into account before you decide to invest in money market funds. Here’s a brief overview of some of the key things that you need to take into account.

• Risk

  Though the risk is far lower than other market-linked investment options, money market funds do carry certain risks. This includes credit risk, interest rate risk and reinvestment risk. That said, funds that invest in riskier money market instruments have the potential to deliver higher returns as well.

• Returns

  The average rate of return of money market funds may be higher than that of savings bank accounts. However, the returns are not guaranteed. The Net Asset Value (NAV) of the fund will change depending on the prevailing interest rates in the market.

• Expense Ratio

  The expense ratio represents the cost associated with the management of money market mutual funds. It is levied as a percentage of your investment capital. According to the Securities and Exchange Board of India (SEBI), fund houses can levy a maximum expense ratio of 2.25%. Investing in funds with high expense ratios can end up lowering your returns. Therefore, remember to always check the costs associated with a fund before investing.

• Tenure

  The tenure of most money market instruments is only up to a year. Investing in these funds would only be ideal if your investment horizon also matches the tenure of the instruments.

• Taxation

  Money market mutual funds are classified as debt funds. The returns from these funds are taxed according to the holding period. For instance, if you hold the funds for less than 36 months (3 years), the gains are categorised as Short-Term Capital Gains (STCG). These gains are added to your total income and are taxed at the income tax slab rates applicable to you. On the other hand, if you hold the funds for more than 36 months (3 years), the gains are categorised as Long-Term Capital Gains (LTCG) and are also taxed at the income tax slab rates applicable to you.

Conclusion

Money market mutual funds are great additions to your portfolio. They’re liquid, less volatile, and produce returns that may potentially be higher than savings bank account rates. Furthermore, there are different types of money market funds that you can choose from.

If you prefer investing in money market mutual funds, m.Stock may be able to help you out. Our superfast trading platform allows you to purchase mutual fund units in just 2 clicks. All you need to do is select the list of money market funds available in the market and place a buy order. With m.Stock, you get to enjoy zero commissions and up to 1% extra return on direct mutual funds.