Where Do I Keep My Savings? Money Market Fund

This is the fifth article in a series of articles exploring the main places to keep your savings for maximum benefit according to the reasons you are saving for. 

We began by exploring the 7 main places to keep your savings, delved deeper into the usefulness of keeping savings in a current account and whether you should even consider it as an option at all. 

Next, we looked at a regular bank savings account and discussed whether it is a good enough account to keep your savings and the purposes for which it is most appropriate. 

The fourth article explored the pros and cons of a fixed deposit account, its interest rates and whether it is a good place to stash your emergency fund among other potential uses. 

Today, we venture into yet another related vehicle to keep your savings that you should consider as you explore all options - Money Market Funds (MMFs). 

What is a Money Market Fund?

Money Market Fund is a low-risk investment vehicle that aims at delivering returns above the prevailing inflation rates. It basically comprises pooled resources from different people.

MMFs are in many ways similar to mutual funds since funds are collected from many different investors and are managed by professional money managers on behalf of the investors. 

The main difference between MMFs and mutual funds is the degree of risk. Mutual funds invest the pooled money in relatively higher risk securities such as stocks and bonds - investing in mutual funds requires the investor to accept the possibility of a certain degree of loss on the principal.

A MMF on the other hand, is technically a type of mutual fund that only invests in very low risk investments such as Treasury bills and bonds that are issued by the government. There is literally no risk of loss of the principal amount - but with low risk, also comes low rewards in terms of comparable potential interest. 

Money Market Funds contribute to the development and economic stability of a country by facilitating short-term liquidity to banks, governments, and other well-established large organizations. People with surplus money that they don’t need immediately can put it in the money market and earn some interest.

After interest is earned it is shared amongst the investors depending on how it performed overall in a certain period.

Is Your Money Safe in an MMF?

When speaking about security, MMFs must be among the safest investment vehicles available. It comes second to treasury bills and bonds.

MMFs are regulated by the Capital Markets Authority (CMA). CMA has set strict guidelines that are meant to protect the investor and ensure that their funds are properly managed.

For example, the CMA puts a limit on the amount a manager can invest in an area to 25%. So if your manager lends out to a few banks then one of them defaults, you will be guaranteed no more than 25% loss on your investment.

But that kind of loss seldom occurs as fund managers do their due diligence before using the investor’s money in some way.

The probability of losing the money you have stashed in a money market fund is minimal since the managers invest in short-term, conservative, and low-risk areas like commercial papers and treasury bills.

No loss has been heard of or reported in the past 10 years. This makes MMFs relatively safe for a person looking to save.

Advantages of Money Market Accounts

• Easy Accessibility:  One of the main benefits of having this account is its liquidity without a maturity date. It is convenient for the person saving to access their money for any purpose with this account. As long as they haven’t surpassed the transaction limit of their account, transactions can be done smoothly. This makes a money market account one of the ideal places to keep your emergency savings. 
• Higher Interest Rates -  MMF accounts can generate greater interest as compared to other banks accounts including savings accounts. Since its interest rate is compounded and credited every month, an MMF gains more profit as the balance increases. You often are guaranteed rates higher than the annual inflation - so your money never loses its value. 
• Low-Risk and Safe Investment: A money market fund is a great instrument to safeguard the owner’s investment and as well make some money at a lower risk. 

We have already mentioned that the money is used to invest in low-risk instruments and short-term bonds and that CMA has policies that protect the investor against losing their principal. 

• Transparency: MMF accounts keep any fees charged transparent when they are deducted from your account. You generally are not charged any fees to operate an MMF account. 

Depending on the institution, however, you are saving with, the number of free withdrawals can be limited to a certain number per month and any other withdrawal henceforth in the same month charged. 

Disadvantages of Money Market Accounts

MMFs too have their fair share of drawbacks. Depending on your financial goals, it is possible money market funds could be unfavourable for you.

• Inflation Risk - This is a real concern when it comes to MMFs. Inflation makes the shilling of tomorrow less valuable than that of today. Because returns come at a low rate, they are more prone to inflation risk. For example, if you earn 6% per year on an MMF, but inflation gets to 7%, you would be losing your purchasing power. If perhaps you invest Ksh10,000, the Ksh10400 you’d have at the end of the year wouldn't buy you as much as the initial Ksh10,000. 

• Risk of losing your money - We have said earlier that the money market fund is a low-risk investment. However, this does not disqualify the possibility of losing your money. As other investments have risks, so does the money market fund. If the financial institution is mismanaged, you might lose your money. But such a case has so far not been heard of or reported in Kenya in the last 10 years. 

• Low Transaction Limits - Money Market Funds allow very few free transactions every month so that the funds in the account can be ploughed back in and thereby earn more interest for the investor. 

For instance, most if not all money market funds permit only one free withdrawal per month, any more withdrawals get levied. The best way out of this is to have the MMF as a secondary account in which the holder doesn’t require access to their funds for a considerable length of time. The primary account could be a current account.

• Capital Risk - Although the risk overall is small, money market funds don't carry the same KDIC insurance as savings accounts and fixed deposit accounts. In fact, it is not insured by the Kenya Deposit Insurance Corporation. This renders money market funds with a slightly more aggressive risk profile than other similar investments.

Read Also: Cytonn Saga: Ups and Downs of Investing In Unregulated Products

Returns May Vary

Money Market Funds generally invest in government securities and other entities that are considered relatively safe. However, fund managers may take some risks to achieve higher yields for the investors. 

For example, the fund may invest in bonds or commercial papers that carry an additional risk. So investing in the highest-yielding MMF may not always be the safest idea given the additional risk. 

Remember, the return rate a fund posted in the previous year isn’t necessarily an indication of what the rate in the future years will be. 

WRAPPING UP

Do you think the advantages of MMFs outweigh the disadvantages? If so, the MMF may be a good alternative to your regular savings account, a current account or even a fixed deposit account when you consider the specific returns forecasted by the fund manager. 

It is important to also do your due diligence on the money market funds packages that financial institutions have to offer before committing to one. We all want the best possible returns on our money, don’t we?