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