What is money market and how it is related to money market funds

It is simple, if you don’t understand coconut, you won’t understand coconut ice-cream. If you don’t understand apple, you won’t understand apple pie. Likewise, if you don’t understand the money market, you won’t understand money market funds. So, before knowing about a money market fund, let’s first answer the question – ‘What is money market’?

What is money market?

Take a guess, what do you think a money market is? Is it a market wherein you can trade only in hard cash? Or is it a market where you can borrow money? Well, it is neither! It is in fact a market wherein you can buy or sell short-term financial instruments. These securities are highly liquid because they have a maturity period of up to one year. Treasury bills, commercial papers, and certificate of deposit are some examples of money market instruments.

Now that you have the answer to the question ‘What is money market?’, up next is the meaning, taxation and benefits of money market mutual funds.

What are money market funds?

Money market mutual funds invest in money market instruments. Such funds are highly liquid and are therefore treated as near-cash investments. You can get the money in your bank account on the same or next day of redeeming your investment. Such funds also have a very low interest rate risk and credit risk because the investment is in short-term instruments with strong credit ratings. Also, the Net Asset Value (NAV) does not fluctuate majorly because the underlying securities have a short maturity period. Thus, you can expect steady returns with money market mutual funds.

These features make money market mutual funds suitable for risk-averse investors who are looking to earn returns in the short term.

How are money market funds taxed?

Such funds are subject to the same tax rules as other debt mutual funds. The amount of tax that you have to pay on your gains from money market funds will depend on the time for which you stay invested in the fund.

• If you redeem your investments at or before 36 months, your gains will classify as short-term capital gains and will be taxed as per your income tax slab.
• If you redeem your investments after 36 months, your gains will classify as long-term capital gains and will be taxed at 20% with indexation benefits.

What are the benefits of money market funds?

1. High liquidity: You can convert your investment into cash quickly and easily.
2. Low risk: Investments in high-quality short-term securities keep the risk level of such funds low.
3. Higher returns: They have the potential to deliver better returns than traditional saving instruments such as a savings bank account.
4. Flexibility: You can use such a debt mutual fund to park your savings and gradually transfer the money to equity mutual funds. This will help you gain from the potential of equity but without facing volatility at once.

Should you invest in money market funds?

Money market mutual funds can be your go-to funds in the following cases:

1. If you want to earn a steady short-term income
2. If you want a better alternative to a savings bank account
3. If you want to park your surplus funds for a short investment horizon
4. If you want a systematic way of investing in high risk-return funds
5. If you are a risk-averse investor wanting to invest in mutual funds

To sum it up

Money market funds are relatively safe, stable and liquid debt mutual funds in India that are ideal for parking surplus funds and meeting short-term goals.

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