Money Market Funds: All You Need to know in Detail

What is a Money Market Fund?

A money market fund is a short-term debt fund that makes investments in very liquid, short-term securities. It invests in several low-risk, high-quality short-term debt securities such as government bonds, commercial paper, and certificates of deposit. These funds have an average maturity period of over one year.

Money market funds provide investors with high liquidity and are regarded as low-risk investments. These funds are popular among investors looking to invest for the short term with expectations of decent returns. They offer the opportunity to earn a higher return on short-term cash holdings than traditional savings accounts.

Features of a Money Market Mutual Funds

MMF investments offer a rather unique blend of safety and accessibility. Indeed, here's what makes them tick:

Short-term investments: MMFs deal in high-grade debt maturing in a year or less. Think government bonds and certificates of deposit (CDs).

Low risk, low reward: Their low-risk approach means that MMFs have a low chance of losing your money. The flip side is a slightly lower return compared to the riskier investments.

High liquidity: Need your cash fast? No problem! Unlike fixed deposits, MMFs generally allow easy withdrawals, making them a great parking spot for short-term savings.

Types of Money Market Funds

The following are the types of money market funds:

Liquid Funds: These funds are extremely low-risk and liquid since they invest in money market securities with maturities of up to 91 days.

Ultra Short Duration Funds: These money market funds are slightly riskier than liquid funds as they invest in debt and money market securities with maturities of up to six months.

Short Duration Funds: These funds are slightly riskier than ultra-short-duration funds because they invest in debt and money market instruments such that the Macaulay Duration of their portfolio is 6 to 12 months.

Overnight Funds: These money market funds are exceptionally low-risk and highly liquid because they invest in assets that mature overnight, including tri-party repo, collateralised borrowing and lending obligations (CBLO), and repo.

Money Market Funds: These invest in various money market instruments, including commercial papers, certificates of deposits, treasury bills, and short-term bonds, making them significantly riskier than liquid funds.

How a Money Market Fund Works?

Money market funds purchase short-term, low-risk debt instruments by pooling funds from several investors. As the median maturity of these securities is 13 months or fewer, there is less chance of high impact of interest rate changes and credit defaults.

You, as an investor, can buy shares of the money market funds and sell at the Net Asset Value (NAV), and investors normally have access to this market every day. In order to maintain the required amount of liquidity and stability, the fund manager will employ investor cash inflows and outflows to buy and sell securities. Although they nevertheless contain some risk of loss, money market funds are typically seen as a low-risk investing alternative. They must adhere to tight investing criteria to guarantee liquidity and stability.

Function Of Money Market Funds

A money market keeps the hum in financial zones. Here is how:

Central to lending and borrowing: Companies and governments can acquire short-term cash for everyday needs, while investors can lend their money for quick returns.

HUB of Liquidity: Need cash in a hurry? Well, the money market is such a platform that quickly converts investments into spendable funds.

Interest rate barometer: The money market mirrors the short-term interest rates, extremely useful information for businesses, investors, and even central banks in making any well-reasoned financial decisions.

How to Invest in Money Market Funds?

Investing in money market funds is a simple process. Firstly, you need to choose a mutual fund company or financial institution that offers money market funds. Then, you need to fill out the necessary application forms and provide the required KYC (Know Your Customer) documents such as Aadhar Card and PAN Card. Make the payment.

Once you invest in money market funds, you must track them regularly and review their performance periodically. Money Market Funds are not risk-free, and the returns may depend on the market conditions. Therefore, investors must do proper research and consult with a financial advisor before making any investment decisions.

Advantages and Disadvantages of Money Market Funds

Despite being extremely liquid investments, there are a few things we need to be certain of in order to fully comprehend the long-term advantages and disadvantages of money market funds.

Advantages of Money Market Funds

1. Liquidity: Money market funds offer a high level of liquidity, whereby an investor can get money easily and quickly at any point in time.

2. Safety: They generally invest in short-term, high-quality securities that lower the prospect of losses.

3. Competitive returns: Compared to a regular savings account, the money market fund can provide more attractive interest rates.

4. Diversification: Through these diversified investments in several securities, it spreads out the investment risk associated with money markets.

5. Convenience: Several money market funds offer features such as check writing and debit card access options to assist in utilizing your money.

Disadvantages of Money Market Funds

Being a debt mutual fund, there is credit risk involved in investing in money market instruments. Credit risk refers to the issuers’ failure of meeting their interest and/or principal payment obligations.

If the investing company decides to change the fund’s structure, some money market funds may ask you to lock in your money. Any party can choose to have all of their money locked in for two or three years at a time.

Money market funds are slow earners, but waiting to see your money grow could mean missing out on other types of mutual funds that can earn far more quickly.

Taxation Rules of Money Market Mutual Funds

1. Interest Income: Taxed as ordinary income, depending on your income level.

2. Capital Gains: Short-term gains are taxed as ordinary income and long-term gains at a lower rate.

3. Tax Reporting: Gains and income are reflected in your annual tax return.

4. Exemptions: Some municipal funds may be exempt from federal taxes