What are money market mutual funds? Definition, types & benefits

If you are investing in mutual funds to accumulate money for your short-term goals, debt funds can offer you many options. Among the spectrum of 16 debt funds, money market mutual funds stand out as a compelling choice if you are seeking stability and liquidity. However, as with all investment schemes, financial prudence dictates that you must understand what is in store for you. So, before you pick a suitable money market fund, give this guide a read to know every important thing about these mutual fund schemes.

What is a money market?

The money market is a segment where financial instruments with short-term maturities such as treasury bills, commercial papers, and Certificates of Deposit (CDs) are actively traded. These securities generally have a maturity period of one year or less and can be quickly bought or sold in the market. High liquidity is one of the reasons why the money market is often seen as a low-risk market.

Let’s now move on to money market funds.

What are money market mutual funds?

Money market mutual funds are a type of debt fund. These funds allocate their investments to a variety of money market instruments, which typically have a maturity period of up to one year. Money market funds are low-risk investments that can offer liquidity. They are also known for their moderate return potential.

To better understand these mutual funds, it is important to know more about the types of instruments they invest in. Let’s find out.

Types of money market instruments

• Treasury bills (T-bills): Issued by the Government of India, T-bills are short-term instruments with maturities of up to 365 days. They carry low risk and typically generate lower returns compared to other money market instruments.
• Certificates of Deposit (CDs): CDs are short-term debt instruments offered by commercial banks. They have fixed terms and interest rates and can be used as an alternative to fixed deposits.
• Repurchase agreements (Repos): Repos are short-term loans, commonly between banks or a bank and the Reserve Bank of India (RBI).  
• Commercial Papers (CPs): CPs are short-term debt instruments issued by highly rated companies and financial institutions to cover their financial obligations.

How do money market funds work?

Money market mutual funds invest in a diversified portfolio of money market instruments, such as T-bills, CPs, and CDs. They pool money from different investors and invest it further in these short-term instruments. The returns generated by these funds are closely linked to the prevailing short-term interest rates in the market.

Who should invest in a money market fund?

Money market funds are designed to be relatively low-risk investments, as they focus on highly liquid and secure instruments. Their emphasis on stability and liquidity makes them a suitable option for investors seeking a balance between moderate returns and low risk. These funds can also be easily accessible, which is why they are commonly used for parking idle funds in the short term.

You can invest in a money market mutual fund if your goal is to preserve your principal investment and save for a short-term goal.

Factors to consider before investing

Here are some factors to keep in mind when investing in money market mutual funds:

• Risk: While debt funds may not pose as much risk as hybrid funds or equity funds,they are not entirely immune to risk. They carry risks like interest rate risks and credit risks.
• Expense ratio:You will be required to pay a small percentage of the total assets as the expense ratio when you invest in money market funds. It is essential to factor in this cost to maximise your returns.
• Credit quality: It is important to pay attention to the credit quality of money market instruments and invest in a fund that chooses high-quality securities. 
• Taxation: Money market funds follow the taxation rules applicable todebt funds in India. For debt funds with 35% or less of their assets in equities, any gains are treated as part of your taxable income and taxed based on the income tax slab you qualify for. On the other hand, if debt funds have more than 35% but less than 65% equity allocation, the gains are considered Long-Term Capital Gains (LTCG). These gains are subject to a fixed tax rate of 20% with the benefit of indexation.

How to invest in money market funds?

You can invest in money market mutual funds in two ways:

• Systematic Investment Plan (SIP):You can opt for an SIP and contribute a fixed sum at regular intervals, like weekly, monthly, etc.
• Lump sum:You can choose the lump sum method and invest a single, larger amount at once.

Conclusion

While money market funds are a seemingly stable investment option, it is still crucial to analyse factors such as fund objectives, portfolio composition, etc. Make sure to also understand the types of money market instruments and their functioning to make informed investment decisions.

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