What is a money market fund and what is worth knowing about it?
Money market fund represents the lowest risk of mutual funds. Accordingly, their proposed time horizons are also the shortest and their yield prospects are also the lowest.
Nevertheless, in Europe the total value of assets managed in money market funds is roughly € 1 trillion. They account for about 15% of asset management services. All this shows that there is a strong demand for almost risk-free money market funds.
What does the money market fund invest in?
The vast majority of money market funds invest in bank deposits or short-term debt securities. These securities can be government securities, certificates of deposit, and normal commercial securities (i.e., even corporate bonds). What they have in common is that their maturity is short, within a year, but occassionally do not even exceed 60 days.
The 15% stake mentioned above means that about 20% of government securities are bought up by money market fund asset managers.
Types of money market fund
These mutual funds can be grouped by maturity as well as by changes in their asset value.
Grouping by change in asset value
Money market fund with variable net asset value
Its units are adjusted to normal market conditions. It can be purchased and redeemed for one share of the net asset value at any given time.
Fixed net asset value money market fund
The purpose of this type of fund is to keep the net asset value per unit constant so that their price does not change. As the number of units changes, they adjust their fixed assets accordingly. These funds are required to invest the majority of their assets in government securities.
Low volatility net asset value money market funds
This type of mutual fund is a mixture of the above two, a relatively new category compared to the above. The net asset value per unit, so that their price can fluctuate within a certain threshold, is otherwise constant.
Grouping by maturity
It holds investors’ money in assets with a maturity of no more than 60 days, so it is less exposed to any exchange rate fluctuations.
Money market fund
They can keep their money in securities and bank deposits with a maturity of up to 6 months. Due to the longer time horizon, they can be slightly affected by exchange rate changes, which last for about 2-3 weeks.
Yield of the money market fund
Although there are differences in the returns of money market funds, this is more the exception. If you look closely, returns around 0% are the most common. This is partly due to the fact that the yield on government securities is not very high either, and if you look at the interest rates on bank deposits, you may find that it is also around 0%.
The return of the fund depends largely on what assets the asset manager chooses for the portfolio, as well as their maturity.
How do you use the money market fund?
Of course, you can achieve the same return with normal deposits. You will then need to pay the account management fee, cash withdrawal fee and interest tax to the bank. You also have to look at the special offer options, and you cannot withdraw your money without losing interest until the end of the booking period.
The money market fund will solve this for you. It produces the same return as a bank deposit, only more cost-effectively and while conserving liquidity. The latter means that you can redeem your money market fund unit at the current price at any time, so you don’t actually have your money tied up.
The money market fund can be used as an open-ended alternative to term bank deposits.
Can you build capital with a money market fund?
I do not recommend neither the bank deposits nor the money market funds for capital building. There are basically two reasons for this. The bank deposit is not designed to bring you above inflation, so the purchasing power of your money (the value of how many products and services you can buy from a given amount of money) will steadily decline.
The picture shows the development of inflation in 2019 globally. You can see that almost anywhere you look, it is much higher than what you can achieve with a money market fund.
The other reason why I do not recommend you the money market fund to build capital is the following: during the same time period, an equity fund can generate far much more for you. Although it has a higher level of risk, when used properly, it puts more money in your pocket without you working more yourself.
Most investors use the money market fund as a kind of “financial buffer” during periods when the market is waiting. You already have an exit point in one place, but you don’t have an entry point in another, you can use the risk-free money market fund.
The same situation, for example, before a major election, can be a kind of escape route in addition to gold. Some people use this consciously, get out at an even higher point, and then land back at the low point.
This is how you can use the money market fund
As for equity funds, I have already mentioned to you that those funds contain 70-90% equities. If you want to build capital, you can do the same yourself.
In addition to high-yield equity funds, keep a small portion of your money in a risk-free location. The money market fund is a very good opportunity for this.
The advantages of this are, that you can:
- take advantage of a given buy position (e.g., a temporarily undervalued equity fund), you do not have to sell another asset that is also undervalued.
- track any changes in your life situation without having to sell your long-term investments.
- get out of a bond fund / equity fund to realize your returns and find a new place for your money by standing still. This is when you no longer run the risk of losing the return you have already achieved.
Money market fund risk
The risk of a money market fund is very low when measured against bond funds and equity funds, as well as virtually any other investment fund, but still not 0.
Let’s take a look at the risks you need to be aware of as an investor:
Interest rate risk
In the case of money market funds, a fall in the exchange rate can occur if the central bank suddenly raises interest rates and the yield on government securities rises sharply.
The effect of the central bank interest rate increase: in this case, the demand for government securities in the money market fund, which are close to maturity, decreases, so their exchange rate also decreases. This, in turn, adversely affects the net asset value of the investment fund, and therefore its exchange rate.
When the central bank raises interest rates, the profits available on risk-free forms of investment increase, so money flows there more from the money market fund. Therefore, the price of investment certificates decreases.
Credit and counterparty risk
Although the fund manager selects the assets that may be included in the fund’s portfolio with the utmost care, this risk nevertheless exists. In the case of debt securities and bank deposits, there is a possibility of bankruptcy of the issuing institution. In this case, due to insolvency, the value of these assets will be zero, which will also reduce the price of the investment fund.
Risk arising from economic regulation
Changes in money and capital market conditions also affect the fund manager’s capabilities. Changes in the inflation environment and tax rules also affect the exchange rate of the money market fund.
The money market fund attracts a significant amount of capital due to its low risk. This provides an opportunity to stimulate the economy through the debt securities in the fund.
It is also recommended for risk-seeking investors to use them in a relatively small percentage, as this creates a kind of “financial playing field” for themselves. And risk-averse investors can take advantage of the opportunities offered by bank deposits and government securities without committing and always looking for the best interest rate option.
- Have you used money market funds before? What was the result?
- What do you think in what portion it is useful to use money market fund if you want to implement capital building in the most efficient way possible?
- In your opinion, what is the maximum time period during which you still consider the use of the money market fund to be good?
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