Debt-based mutual funds are money market funds (MMF). They are designed with the intention of giving reasonable and consistent returns while maintaining the investment’s liquidity. It’s crucial to keep in mind that MMF has relatively short durations, with an ideal maturity period of 12 months on average. These are just a few of the explanations for why MMF are thought to be relatively low-risk.
How Do They Function?
As implied by their name, money market funds in India invest in the following short-term money market instruments:-
Treasury Bills
The Government of India issues Treasury Bills, also referred to as T-Bills. With a typical time frame of one year, the goal is to raise capital. These are among the safest investment options because they are backed by the government. However, as one would anticipate, because there is virtually no risk involved, the returns are also somewhat on the lower side.
Certificate of Deposit
Commercial banks with the necessary permission and authority issue certificates of deposit, also known as CDs. These have a fixed term and, unlike a typical Fixed Deposit (FD), do not permit early redemption. The rest of the fundamental ideas are essentially unchanged.
Commercial Paper
Financial institutions with typically high credit ratings issue Commercial Papers, also called CP or Promissory Notes. These are unsecured, short-term loans. They are provided at a reduced price, but they must be redeemed for the full amount of the original note. The benefits of short-term borrowing from various sources for investments and operating costs go to the companies, while the investor receives returns in the form of the delta price between purchase and redemption.
Repurchase Agreements
A Repurchase Agreement, also known as a Repo, is a contract between two banks. The Reserve Bank of India (RBI) is typically one of the two banks. In essence, it suggests that the two banks involved have a loan agreement.
As you have probably noticed, the commonality among all of the aforementioned money market instruments is low-risk, predictable, and steady (albeit lower) returns.
Benefits and Considerations for Investing
The features and operations of money market funds must now be understood by the reader, and they must also be aware of the things to think about before investing in them.
Lower Expense Ratio
The associated costs of fund management are very low because the primary goals of these debt funds are to safeguard the principal and invest in short-term gains. This is a crucial factor because the returns are lower in any case. The fund manager, market research analysts, etc. do not further dilute the gains; rather, they are returned to the investor as part of the returns.
Returns and Risks
Money Market Funds in India primarily serve the purposes of offering stable returns, safeguarding your principal investment, and reducing risk exposure, as was stated throughout the article. Although these funds tend to offer higher rates than savings accounts while maintaining the same benefit of keeping the investment largely liquid, they do carry some of the risks associated with debt funds to some extent.
Tax
Money Market Funds are a subset of Debt Funds as a whole. As a result, they are taxable in accordance with local law and are subject to indexation benefits as well as STCG (Short Term Capital Gain) and LTCG (Long Term Capital Gain). The STCG applies if the funds are retained for up to three years. LTCG is applied to periods longer than three years.
Investment horizon
These funds are appropriate for three to one year long short-term investment goals. Choose dynamic bond funds if your investment horizon is moderate.
Financial goals
Money market mutual funds are a good option if you’re looking for a short-term place to park extra investable funds that would yield better returns than standard savings accounts.
Money market mutual funds are in competition with other debt-related investments as well as conventional investments. Although they aim for higher returns, these funds invest in a wider variety of assets.
These funds’ main goal is to provide secure avenues for investing small amounts of money in debt-based assets and secure, highly liquid cash equivalents. These programs are low-risk, low-return investments in the mutual fund investment format.
So these funds have the advantage of being very liquid, inexpensive, and intended to provide higher returns than a bank’s savings account.
On the other hand, because they are unsecured investments, their value is susceptible to shifts in the interest rate environment. Second, capital gains are considerably less.
Who should invest in money market mutual funds?
Mutual funds that invest in money markets aid in portfolio diversification. The main goal is to produce low-risk short-term returns through investments in reputable money market instruments. To achieve the highest short-term gain, the corpus is invested in a well-diversified portfolio. These funds are open to investors with high liquidity and a one-year time horizon for investments.
Additionally, money market fund schemes that produce predictable returns in the short term are a good option for low-risk investors seeking higher returns than those offered by conventional investment options like fixed deposits.
Money market mutual funds might not be the best choice for you, though, if you have a long time horizon for your investments. Instead, you should put money into balanced or dynamic bond funds, which are still low-risk options that can produce higher returns than money market mutual funds.
Summary
Money market funds are debt-based mutual funds that invest in short-term, low-risk money market instruments. They are designed to provide reasonable and consistent returns while maintaining liquidity, with an average maturity period of 12 months. Money market funds offer lower expense ratios compared to other funds, which means lower costs for investors. These funds are suitable for short-term investment goals and offer higher returns than savings accounts while maintaining liquidity. However, investors should consider the associated risks and tax implications before investing in these funds. Money market funds are an excellent option for low-risk investors seeking higher returns than those offered by traditional investment options like fixed deposits. Overall, money market funds provide a secure and liquid avenue for investing small amounts of money in debt-based assets, making them a valuable addition to any investor’s portfolio.
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