In the current economic climate, it can feel difficult to know where to invest your money and earn interest. If you are interested in investing, there are a few choices that can be both safe and profitable. One of the best ways to invest effectively is to learn about money market funds.
Money market funds provide investors with stable returns and low-risk investments. This blog article will discuss the reasons why you should invest in a money market fund, as well as steps you should take to find the best money market fund in Kenya.
What are money markets Funds?
Money market funds are a type of mutual fund that invests in short-term securities with maturities of one year or less. These short-term securities include cash deposits and debt securities such as government treasury, government bonds, and commercial papers, among others.
Money market funds are also known as money market mutual funds, and they offer investors high liquidity and low risk. Investors use money market funds to manage cash or as a short-term saving alternative.
Money market accounts
You must be wondering whether money market funds and money market accounts are the same thing. No, these two are different.
A Money market account is an interest-earning savings account. It’s mostly offered by financial institutions such as banks and microfinance organizations. They offer better earnings and easier access to money than normal savings accounts.
How do money markets Funds work?
Money market funds managers assemble a portfolio of securities and sell shares to investors. The investors will earn an income and make capital gains. Money market funds include securities such as cash and cash equivalent and debts in their portfolio.
Money market funds have the following instruments:
- Certificates of deposit
- Commercial papers
- Repurchase agreements, among others.
- Government bonds
- Treasury bills
The return from a money market fund depends on several factors, such as applicable market interest rates, risk profile, and management cost, among others.
Money market funds terms you should know
Before you invest in any money market, make sure you look through the minimum fund disclosure document. The document gives information such as the objective of the fund, risk profile, asset composition, and much more.
Let us look at the terms you will find in the minimum disclosure documents.
This tells you the expected risk, whether it is low, low to moderate, moderate, or high.
Recommended investment term
The recommended investment term is the best duration to invest in a fund.
The objective of the fund
Most funds will seek to give investors a return and ensure capital safety.
A fund’s benchmark is the comparable and replica index. For instance, some funds will have a benchmark of 182-day T-bill + 1% p.a.
Funds inception date
This is the date the fund began.
This is the minimum investment you can make. It’s the price of one share.
This is the size of the fund.
Income distribution frequency.
The income distribution frequency is how often the fund pays out interest. Most money market funds pay an income every month.
These are instruments that make up a fund.
The maturity profile shows the number of investors who invest for a certain period. Most funds show a maturity profile of 3 months, 3-9 months, and above 9 months.
Effective annual yield
This is the total yield an investor receives.
Money market fund performance.
This shows how the fund performs in comparison to the benchmark.
These include fees such as management fees. In this section, you will also find the 12-month total expense ratio. The total expense ratio (TER) is the measure of total funds’ assets that are used for administration and other expenses. It’s the cost associated with the management of the money market funds. The higher the TER, the more it reduces your returns.
You can calculate the TER by
TER=Total Funds costs/Total Fund Assets
The Sharpe ratio helps you understand the return of an investment as compared to the risk.
Fund managers’ commentary
In this section, the fund manager seeks to explain the fund’s performance and what can be expected in the future.
How to choose the best money market funds
There are many money market funds available in Kenya. Here is how to choose the best.
Check the fund expenses.
Fund expenses affect your returns. The higher the expenses, the lower the returns. Look out for the management fees and other costs the fund will charge. Although this should not be the only consideration you should make when choosing a fund, pick one that has lower fund expenses.
A higher fund total expenses ratio (TER) is an indication that the fund managers incur more costs to manage the fund. Choose a fund with a lower TER.
Look for the fund with the best yield.
The higher the effective annual yield, the more payout you will get from a fund. Since the fund yield may fluctuate daily, always pay attention to current and historical yields.
Another way to look at it is to compare the yield to expense ratio.’
Check the asset composition of the fund.
The risk associated with a fund depends on the asset composition. The asset composition is the instrument the fund manager chooses to make up the portfolio. It’s important to know where the money you invest will go.
Most money market funds have a low risk, but that does not mean you shouldn’t assess the instruments. For example, the safest MMFs invest a large portion of their assets in government treasury bills. The riskiest funds invest a large share of their money in instruments such as corporate securities.
Lower-rated debt instruments carry a higher risk of default and may offer a higher yield to compensate for the risk. Money market funds offering higher yields are most likely investing in more risky instruments. By looking at the asset composition, you will be able to know the money market fund risk.
Comply with all regulatory requirements.
Your preferred choice of money market fund should follow the regulations set out by the capital market authority. No matter how good the interest a fund is offering, if it’s not regulated by the CMA, it’s a risk to invest in it.
The benefits of money market funds
Money market funds provide investors with an array of benefits. Here are the main benefits.
Money market funds invest in securities that mature in a short period and can be liquidated into cash within a few business days. Most funds take a day or two to settle, and you can transfer the money to an account that allows you to use it.
Most money market funds invest in low-risk instruments. Although the return on money market funds is lower as compared to a portfolio heavily invested in stocks, it has limited risk.
Money market funds are a safe place to park your money while you earn an income. The low volatility of the funds guarantees the safety of your money.
It’s easy to invest and withdraw your money from money market funds. You earn an income, and you have easy access to your money.
Compared to savings accounts, money market funds offer a higher yield. They provide investors with higher yields than conventional savings accounts.
Although money markets are generally low risk, they come with inherent risks such as inflation and interest rate risk.
- Inflation risk occurs when the cash flow from the funds drops due to inflation. High inflation lowers the performance of a fund.
- Interest rate risk is associated with fluctuating interest rates. High-interest rates result in lower yields.
Who should invest in money markets?
Invest in the money markets if.
- You seek a higher return than those from savings accounts.
- Those who want to invest for a short time before they move the money elsewhere,
- Risk-averse investors
If you’re looking for a safe investment with the potential for modest returns, money market funds are a good option. With these types of investments, you’ll earn interest on your principal while keeping your money relatively safe.
While there are some risks associated with money market funds, they tend to be much lower than the risks associated with other types of investments. If you’re interested in preserving your capital and earning a little bit of interest, money market funds are worth considering.