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Money market funds: Making your money work harder

May 28, 2009 10:13 IST

Do you have excess cash stashed away in your regular bank account? Are you aware that instead of earning measly 3.5% interest that banks pay you on this sum, you can get far higher interest on this amount?

Are you aware of money market schemes offered by mutual funds that let you earn interest as high as high as 7-7.5% per annum on this investment? Read on to know more about this lucrative investment option:

What are money market funds?

Money market funds are mutual fund schemes that invest money in fixed income securities, whose maturity period is below one year. These securities can consist of treasury bills, commercial papers, certificate of deposits, short-term fixed deposits; and call money market.

Most of these securities have a very short maturity period, typically below 182 days. As most of these securities are highly liquid, these funds are also called as liquid funds.

What are the time constraints for these funds?

The maturity period of most of the securities is 182 days. However with effect from May 2009, SEBI has mandated that the funds cannot invest in securities whose maturity exceeds 91 days.

You can withdraw your money anytime by giving a day's notice. At the time of redemption, you get the money invested, along with the interest calculated on daily basis. However remember, some funds do have a lock-in period of 15 days.

What are the returns I can expect?

While no investment assures guaranteed returns, even money market schemes do not assure guaranteed returns. This is because the returns generated by these funds depend on the interest rate on the underlying securities.

As the rate changes, so do the returns generated. However currently, they are offering a rate of return of 7-7.5%.

What are the pros and cons of these funds?

Pros

  • Higher returns than bank fixed deposits
  • Liquid
  • Safety of capital
  • Low expense ratio, thus allowing you to earn higher returns

Cons

  • Reinvestment risk, as the money can be reinvested at lower rate because of reduction in interest rate
  • No capital appreciation
  • Likelihood of loss of capital because of default of underlying security like commercial paper
  • Has very high investment requirement, as most liquid funds expect a minimum investment of Rs 1 lakh (Rs 100,000). Hence it is suitable for corporates and high net worth individuals.

Is it suitable for me?

If you have surplus funds that you want to use very soon, then liquid funds are for you. These funds should be used only as short-term investment plans.

For long term, it is advisable to invest in equities that will fetch you far higher returns. Before investing any such liquid scheme, always check the CRISIL rating awarded to the scheme. This is because some schemes may take undue risk to generate higher returns.

Also unlike equities, it is difficult to check the reliability of the debt instruments. Follow these instructions and you will benefit from these schemes.

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