Why money market funds are a go-to for low risk investments

Money market mutual funds, commonly known as money market funds, are a popular investment option for those seeking low-risk, short-term investments. Unlike traditional mutual funds that aim for capital gains, money market funds generate returns through dividends (yield), which typically reflect short-term interest rates. 

They are widely regarded as a safe and liquid investment choice, making them attractive for investors who prioritize stability over high returns. In this blog, we will explore why money market funds are a go-to for low-risk investments. 

What are Money Market Funds?

Investments in high-quality, short-term debt instruments, such as municipal and government securities, as well as other securities like commercial paper, certificates of deposit (CDs), and repurchase agreements (repos), are made by money market mutual funds, also known as money market funds.

In order to help control inflation, money market funds offer dividends, also known as yield, which usually mirror short-term interest rates. The yield is the only return on investment for money market funds, in contrast to the majority of other mutual funds or exchange-traded funds, which seek to produce capital gains. The risk of money-market funds is comparatively minimal. Money market fund prices often don't go through the same kind of volatility as stock prices.

Types of Money market fund

Only securities with short maturities (usually 13 months or less) are permitted by law for money market funds to invest in. However, there may be some variation in the securities they invest in. Typically, funds are divided into three primary categories:

• Government: Put cash, government securities, or repurchase agreements secured by government securities at least 99.5% of the fund's total assets.

• Municipal: Invest mostly in municipal bonds, which usually provide yields that are not subject to federal income taxes.

• Prime: Invest in a range of taxable short-term assets, including commercial paper, repos, and bank and corporate debt securities.

Possible advantages

Money market funds are a lower-risk option for investors who might be searching for an alternative to cash holdings because of their stringent maturity, credit quality, and diversification requirements. On any business day, investors can typically sell their shares back to a money market fund at the NAV.

Additionally, because their income may be excluded from federal income taxes, certain municipal money market funds may provide benefits in taxable brokerage accounts.

Possible disadvantages

Although they are uncommon, money market funds have occasionally dropped below their $1 NAV, which has caused investors to lose some of their investment's principal value—a situation known as "breaking the buck." It is also possible for money market funds with fluctuating share prices to lose value.

Money market funds may impose liquidity fees or redemption restrictions during times of market stress.

Importantly, unlike CDs and other bank deposits, money market funds are not guaranteed or insured by the Federal Deposit Insurance Corporation (FDIC) or any other government organization.

How to assess money market funds

Investors may wonder, "Should I just invest in the fund with the highest yield?" when assessing money market funds. The quick answer is that, other than yield and past performance, there are a lot of other aspects to take into account.

The net expense ratio, for example, shows what proportion of a fund's assets are used for management fees and operating costs. The initial investment minimum, which for retail funds can vary from a few thousand rupees to several hundred thousand rupees, is another thing that investors would want to consider.  

Bottom Line

Money market funds are less risky investments with little potential for financial gains but the ability to provide liquidity and income. When capital preservation is the main goal, money market funds might help offer a possibility for investors with short time horizons. It's crucial to think about diversifying your holdings and comprehend any possible risks connected to a certain security, just like with other investments.

Additionally, because every money market fund is unique, investors should evaluate a fund's features and prospectus to ensure that it fits with their own financial objectives. For those looking to preserve capital while earning moderate returns, financial institutions like JS Bank offer money market funds tailored to various investment needs