What is a Money Market Fund? Definitions, Benefits and Features

Investing your hard-earned money can be hectic, especially if you are looking for a safe, low-risk option. Enter Money Market Funds (MMFs)—a reliable investment vehicle that offers liquidity, stability, and peace of mind. Whether you’re seeking a secure place to park your funds for the short term or want to maintain an easily accessible cash reserve, money market funds provide an attractive solution. 

In this blog, we’ll dive into everything you need to know about money market funds, including their types, advantages, how they work, and how to invest in them within the Indian market context. Let’s explore how these funds can help you achieve your financial strategy and investment goals.

Money Market Fund Overview

A Money Market Fund (MMF) invests in short-term, high-quality debt securities. These mutual funds aim to provide investors with a safe place to invest, easily accessible, liquid, and relatively low-risk investments. Investors often use these funds to invest their money for short periods or maintain a liquid cash reserve.

Types of Money Market Funds

Money market funds can be categorised based on the types of securities they invest in. Here are the common types:

Treasury Bills (T-Bills)

These are issued by the Indian Government and are short-term securities with maturities of up to one year, commonly available in 91 days, 182 days, and 364 days. These are considered very low-risk investments due to their government backing, typically offering lower returns than other instruments but ensuring high security.

Commercial Papers (CPs) 

These are unsecured, short-term promissory notes corporations issue to meet their short-term funding needs. They usually have maturities ranging from 7 days to 1 year. Although CPs come with a higher risk than T-Bills due to the corporate credit risk, they offer higher returns, reflecting the increased risk.

Certificates of Deposit (CDs) 

These are short-term deposits issued by banks and financial institutions, with maturities generally ranging from 7 days to 1 year. CDs are considered low-risk as the issuing bank or financial institution backs them, and they typically offer competitive returns higher than regular savings accounts.

Repurchase Agreements (Repos) 

These are short-term borrowing arrangements for dealers in government securities. In these arrangements, the dealer sells the securities to investors with an agreement to repurchase them at a higher price at a later date. These agreements usually have very short maturities, often overnight or for a few days, and are considered low risk due to their short duration and government backing. However, they generally provide lower returns.

Call Money 

This refers to short-term funds lent by one bank to another, typically overnight. Due to their short-term nature, these transactions are very low risk, and interest rates can vary based on demand and supply conditions in the money market.

Tri-party Repos (TREPs) 

These are similar to repos but involve a third-party agent facilitating the borrowing and lending process. They typically have overnight maturities and are considered low risk due to the collateral backing and third-party facilitation, providing returns comparable to other low-risk money market instruments.

Treasury Funds

These funds invest primarily in government securities, including T-bills and other government bonds, which makes them very low risk due to government backing. These funds offer modest returns, reflecting the investment’s high security and low risk.

Prime Funds 

These funds invest in a mix of corporate and government securities, offering a balanced portfolio. Due to the inclusion of corporate securities, they carry slightly higher risk compared to Treasury Funds but provide somewhat higher yields, reflecting the diversified investment approach.

Tax-exempt funds

These funds invest in municipal securities exempt from federal taxes. Depending on the credit quality of the municipal issuers, the risk level of these funds can vary from low to moderate. They offer tax advantages, potentially leading to higher after-tax returns for investors in higher tax brackets.

Institutional Funds 

These funds are designed for large institutional investors such as corporations, banks, and government entities. They are low-risk, typically managed to maintain high liquidity and security, and often offer lower fees than retail money market funds, providing slightly higher net returns to institutional investors.

Advantages of Money Market Funds

Investing in money market funds comes with several benefits:

• It is easily accessible and can be converted to cash quickly.
• Generally low risk, primarily when invested in government securities.
• Low volatility, making them suitable for conservative investors.
• These funds provide a steady income stream through interest payments.
• Spread across various short-term instruments, reducing risk.

List of Money Market Mutual Funds

Here are some popular money market mutual funds available in India:

How Do Money Market Funds Work?

Money market funds invest in short-term debt instruments like treasury bills, commercial paper, and certificates of deposit. Fund managers actively manage these investments to maintain liquidity, safety, and yield. The interest earned from these securities is distributed to investors as dividends, which can be reinvested or taken as income.

How to Invest in Money Market Funds?

Investing in money market funds in India is straightforward:

Step 1: Choose a Fund

Research and select a money market fund that suits your investment goals.

Step 2: Open an Account

You can invest through mutual fund companies, banks, or online platforms.

Step 3: Complete KYC

Ensure your KYC (Know Your Customer) details are updated.

Step 4: Invest

Start with a lump sum or set up a Systematic Investment Plan (SIP).

Step 5: Monitor

Regularly review your investments and make adjustments as needed.

Taxation Rules of Money Market Mutual Funds

In India, money market mutual funds are taxed based on the holding period:

If funds are held for less than three years, gains are added to your income and taxed at your applicable slab rate.

If funds are held for more than 36 months, gains with indexation benefits are taxed at 20%.

Risks of Money Market Mutual Funds

Although money market funds are generally considered safe, they do carry certain risks:

• There is a credit risk with the possibility of a security issuer defaulting.
• It also comes with the interest rate risk, as changes in interest rates can affect fund returns.
• In extreme market conditions, funds may face liquidity challenges.
• Returns may not always outpace inflation, leading to a reduction in real purchasing power.

Conclusion

Money market funds offer a safe and liquid investment option for conservative investors or those looking to park their funds for short periods. While they come with certain risks, their liquidity, safety, and stability advantages make them an attractive choice for many. Ensure you understand the fund’s objectives and risks before investing.