Money Market Instruments: 2022 Guide To Investing In Money Market Funds

Mutual funds

Money market instruments invest in short-term debt instruments like cash or cash equivalents with a maturity of up to one year. These mutual funds minimise the fluctuations of their NAV (Net Asset Value) to provide steady interest income. In India, MMFs invest in high-quality instruments like Treasury bills, commercial papers, repurchase agreements and certificates of deposits. With this, they can provide higher returns than bank fixed deposits while maintaining minimal chances of losses. 

This post discusses all the details of money market instruments, their types and benefits, the best money market instruments of 2022 and if you should invest. Read on!

What Are Money Market Funds?

Money market funds are open-ended short term debt funds that invest in money market instruments for steady and low-risk returns. Due to the government providing collateral guarantees and higher returns, these are ideal for risk-averse investors looking for better returns than term deposits. 

How Does Money Market Instrument Work?

Money Market instruments trade short-term financial assets with high liquidity. Large institutions, banks and individual investors can participate in this financial market by lending or borrowing via trading bills and securities. Most people consider these assets to be safe due to their high liquidity and low risk of defaults.  

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*Mutual Fund investments are subject to market risks, read all scheme-related documents carefully. 

Benefits & Features of Money Market Instruments

1. Steady Yields

These mutual funds do not change much in value in response to changing market interest rates. As such, they could earn steady returns through cycles of tightening and easing of interest rates. In a bullish market, these funds make their income from interest, while in a bearish market, they generate capital gains to make up for lower interests.

2. Low to Moderate Risks

Money market funds carry low to moderate levels of risk and could be safe short-term investment instruments. These funds usually invest in highly rated securities like T-bills and bonds with the highest ratings. Hence, these have low credit risk and generally provide stable returns with little volatility.

3. Higher Liquidity

Money market funds invest in securities that mature within a year. Fund managers invest pooled money into highly-rated debt instruments, which can be easily liquidated for cash. Thus, many investors use them to temporarily park their funds. 

Also read: IDCW Plans in Mutual Funds And Their Impact On Your Investments

Objectives of Money Market Instruments

• Help banks to park surplus funds.
• Provide investors with short-term funds at an affordable price.
• Help idle funds to be used as effective investments.
• Provide organizations with funds required for working capital needs. 
• Regulate the level of liquidity in the economy.

Different Types of Money Market Instruments in India

1. Treasury Bills (T-Bills)

The Government of India issues T-bills at a discounted price to raise money and repays its full face value after maturity. These have short-term maturities ranging from 14 to 364 days and are one of the safest instruments as they have the full backing of the Indian government.  

Also read: Which Are the Best Debt Funds In India Right Now?

2. Repurchase Agreements (Repos)

This is a short-term borrowing tool made between a bank and the Reserve Bank of India (RBI) or two banks to manage day-to-day cash flow requirements. The government backs these transactions, which are made as per the market interest rates.

3. Certificate of Deposit (CD)

Scheduled commercial banks can issue a term deposit to individuals, trusts and corporations through promissory notes. Banks usually issue these negotiable deposits at a discount and a maturity period between one to three years. CDs come with low liquidity but are freely negotiable.

4. Commercial Bills

Businesses can issue commercial bills for short-term money requirements. These work like a bill of exchange but provide better liquidity as individuals can freely transfer them for transactions.  

5. Commercial Paper or CPs

Companies and financial institutions with high credit ratings can issue promissory notes known as commercial papers for short-term capital requirements. These are unsecured instruments with a maturity period ranging from seven days to one year. Businesses issue them at a discounted rate decided by the market, and investors can redeem them at full face value. 

Also read: Best Small Cap Mutual Funds To Invest In 2021

Top 13 Money Market Funds To Invest In 2022

Who Should Invest In Short term Money Market Mutual Funds?

1. For conservative investors

Money market funds offer some of the highest short-term income as they have well-diversified portfolios. Their low risks in a short tenure make them ideal for conservative investors looking to park their surplus cash. 

In addition, these funds are a better alternative than regular savings bank accounts due to their higher returns. However, these funds are not advisable for very short-term requirements of less than a year.

2. For investors with a low-risk appetite

Due to their short tenure, money market instruments are not much sensitive to interest rate changes in the economy. Moreover, money market instruments could carry a low risk of defaults as they invest in highly-rated debt securities. As a result, they could be ideal for investors with little tolerance for risks and an investment horizon of up to a year.

Also read: How To Grow Your Money With Mid Cap Funds

Factors To Consider Before Investing In Short term Money Market Funds

1. Risks

Even though people consider these funds safe investments, they do come with a few risks. These carry inflation risks due to reduced cash flows caused by inflation, credit risks from assets in corporate bonds and interest rate risks due to market interest rates.

2. Returns

These debt funds usually provide higher returns than saving accounts. However, a rise in market interest rates can decrease the price of assets and lower returns. 

3. Expense ratio

The expense ratio refers to a small percentage of your fund’s NAV charged by your fund house to manage your investment. As the returns of these debt funds are already low, you may want to pick a fund with a low expense ratio to maximize returns. 

4. Investment goals

Money market funds are best suited for those who want to park their surplus cash or earn regular interest income. These will be ideal for those with an investment horizon of 90 to 365 days. 

Taxation

Money market funds follow the tax structure of debt funds since they invest in debt securities too. 

Short Term Capital Gains (STCG) – If you hold your investments up to a time period of three years, the gains you earn are classified as STCG and the returns are added to the investor’s income to be taxed according to the tax bracket they fall in. 

Long Term Capital Gains (LTCG) – If an investor holds their investments for a horizon of more than three years, the returns are classified as LTCG and are taxed at 20% with indexation benefits, which is nothing but the adjustment of purchase price according to the inflation rate.

 Also read: 10 Large Cap Mutual Funds That Can Be A Part Of Your Portfolio

Final Word

Money market funds let investors access a wider range of debt instruments with maturities up to one year. Thus, they can get higher returns while enjoying the benefits of high liquidity. With no lock-in period or exit loads, you can easily withdraw your funds when you need them. However, investors would be well-advised to carefully consider their financial goals and risk tolerance before investing in them.

FAQs on Money Market Instruments

Before you go…

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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.

This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.