Money market funds are an excellent place to start if you are new to investing. Mutual funds offer the lowest risk levels and are quite simple, to begin with.
Treasury bills and commercial papers are among the instruments traded in this market. These instruments have two things in common: they are short-term and low-risk.
Fixed-income solutions such as money market mutual funds, government or low-risk municipal bonds, traditional bank savings products, and preferred stocks, are popular among investors seeking capital preservation. Each of these financing vehicles offers some protection from an otherwise volatile securities markets and is also an expected stream of income to investors.
Although each strategy has advantages and disadvantages, money market funds are a preferred choice by many investors who avoid risks.
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What is a Money Market Fund?
Money funds are basically mutual funds. It invests in high-liquidity assets such as cash and cash equivalents, as well as high-quality debt-based securities.
These securities typically have short maturities of 13 months or less. When you need money, an asset with high liquidity can quickly be changed to cash.
How Money Market Fund Works
Money market funds act almost the same way as mutual funds. Players offer redeemable unit of shares to investors while complying with financial regulations set by the securities and exchange commission (SEC).
Advantages of Money Market Funds
Money market funds supply liquidity to investors. This is because these funds invest in securities that mature quickly and can be liquidated for cash.
A money market fund withdrawal usually takes less than two working days, and brokerage account investment trades are fairly simple to settle.
2. Risk management
Money market funds serve as a risk management tool because they invest in low-risk, high-liquidity cash equivalent securities.
Money market funds are an option for investors looking to park their money in a relatively safe investment. The Securities and Exchange Commission (SEC) requires that only securities with the highest credit ratings be purchased in money market funds, providing investors with a level of security not found in other fixed-income investments.
This distinguishes them from other investments, such as stocks, which have a higher degree of risk.
3. Higher Yields
Money market funds, in addition to safety and liquidity, have the potential for higher yields than their traditional counterparts which include savings or money market accounts from a bank or credit union.
4. Exemption from taxes
Municipal securities in which money market funds invest are usually free from federal and state income taxes, providing a tax-efficient income.
Disadvantages of Money Market Funds
Money market funds, while considered relatively safe investments, do carry inherent risks some of which are inflation, credit, and interest rate risks.
1. Inflation Risk
This risk arises when the cash flows from a money market fund are reduced due to inflation. In other words, inflation reduces the performance of the money market fund. Money market funds don’t protect against inflation.
Since money market funds are investments rather than savings accounts, there is no guarantee of earnings, and the possibility of losing money exists. When interest rates are low, so are money market rates, earning investors very little. Money market funds are not suitable for long-term investing, and even when interest rates rise, the money in a money market fund is unlikely to outperform inflation.
Scott Bishop, a certified financial planner (CFP) says a money market fund has never had an interest rate that superseded inflation.
It is a great place to keep liquid money in the short term, but during inflation, you’ll lose money on the cost of the things you buy.
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2. Credit Risk
There is no guarantee that you will not lose your money because they are not insured by the NDIC like savings accounts and certificates of deposit (CDs). There is a chance of losing, but it is usually quite small.
3. Low returns
Money market funds typically have lower returns than other funds that include assets such as stocks and real estate.
Money market returns may also drop below the inflation rate, giving investors negative real returns. Interest rates may also fall further, lowering the returns on money market investments.
4. Risk of Interest Rates
This is the risk associated with interest rate fluctuations. Yields and interest rates have an inverse relationship, so when interest rates rise, yields fall and when interest rates fall, yields rise.
5. Environmental changes
Economic policies and government regulations can have a negative impact on the price of money market securities and the financial status of their issuers if the money supply and interest rates are affected by them.
6. Liquidity fees and redemption rates
This entails the establishment of high liquidity fees, which are levied on the sale of shares. Waiting periods are required before redeeming profits from money market funds and are typically implemented to prevent a run on the fund during times of market stress.
7. Foreign exchange risk
This risk is borne by funds that invest in cross-border money market instruments denominated in currencies other than the home currency.
The 5 Best Money Market Funds by ROI (Return on Investment) in Nigeria
1. Nigeria Dollar Income Fund – Chapel Hill Denham Mgt. (Dollar Fixed Income Fund)
The Nigeria Dollar Income Fund is a fixed-income dollar fund that allows holders to invest in US dollar-denominated securities while also diversifying their portfolio against domestic currency depreciation.
The Fund’s earnings are invested in Eurobonds, foreign equities, and money market instruments.
2. Stanbic IBTC Conservative Fund – Stanbic IBTC Asset Management (Bonds/Fixed Income Fund)
The Stanbic IBTC Conservative Fund is managed by Stanbic IBTC Asset Management. It’s a fixed-income fund to maintain the safety of funds with limited exposure to the stock market to profit from the returns applicable to equities.
As a result, the target asset allocation is heavily weighted toward Fixed Income securities. Up to 30% of the fund’s Assets Under Management (AUM) is invested in listed stocks and 70% in fixed-income securities.
3. Coronation Fixed Income Fund – Coronation Asset Management (Bonds/Fixed Income Fund)
The Coronation Fixed Income Fund strives to provide investors with an optimal balance of capital appreciation and income.
The fund is an open-ended fund whose investment objectives are met by making investments in Corporate and Subnational Bonds, medium to long-term FGN bonds, and other fixed-income investments.
4. PACAM Eurobond Fund – PAC Asset Management (Dollar Eurobonds fund)
The PACAM Eurobond is a dollar fund that seeks to provide a constant flow of income and capital conservation and protection for low-risk investors who value asset security and liquidity.
Fixed Income instruments including FGN Bonds, Corporate Bonds, Subnational Bonds, and other investment-grade Fixed Income instruments are invested in by this fund, providing investors with the opportunity to invest in secure and high-yielding Bonds issued by the Federal and State Governments of Nigeria, as well as large corporations.
5. Stanbic IBTC Dollar Fund – Stanbic IBTC (Dollar fixed income fund)
Stanbic IBTC Dollar Fund (SIDF) is a dollar fixed-income fund launched in January 2017 by Stanbic IBTC Asset Management to provide generation of income, diversification of currency, and stable growth in USD.
It intends to accomplish this by investing 30% in short-term USD deposits, 70% of its holdings in high-quality Eurobonds, and 10% in USD stocks recognized and registered by the Nigerian Securities and Exchange Commission.
If you are new to investing, money market funds are an excellent place to begin. I hope this article gave you enough information about money market funds and their advantages and disadvantages.
Frequently asked questions (FAQs)
Generally, the money market fund is a safer form of investment that offers protracted yields.
The regulatory body in the money market fund industry is the securities and exchange commission.