Money Market Funds (MMF): How Do They Work?

Money market funds are short-term investment vehicles that provide investors with moderate returns. MMF invests in very low-risk instruments that generally have a moderate return on investment, making them safe to use. If you’re looking for a moderate way to grow your money, a money market fund is a good option.

MMFs seek to provide investors with a high level of liquidity, safety, and yield. They are often used by individuals and businesses as a cash management tool and are a popular investment for money market accounts. Investors in MMFs can expect to receive a stable income, but they may not experience the same level of capital appreciation as they would with other types of investments.

Now that you know a little bit more about how money market funds work, you may be wondering if they are right for you. Read on to learn more about how they work and the pros and cons of investing in MMFs.

Money market Funds

What is are Money Market Funds?

A money market fund is a type of mutual fund that invests in short-term debt instruments such as Treasury bills, commercial papers, bank deposits, and other cash equivalents. Money market funds are generally very low-risk and offer investors a safe place to park their cash. They are also highly liquid, meaning investors can easily withdraw their money if they need to.

Money market funds are a popular choice for cash management and short-term investing. They can be used to diversify a portfolio and offer a higher yield than a traditional savings account. However, money market funds are not without risk. They can lose value if interest rates rise or if the quality of the underlying investments declines.

In general, MMFs seek to match the interest income earned by regular savings accounts while also providing investors with safety and liquidity. If you’re considering investing in a money market fund, it’s important to understand how they work, and the potential risks involved. We give a quick overview of how money market funds work.

How Does a Money Market Fund Work?

Like other mutual funds, MMFs are made up of several instruments. The fund manager assembles instruments such as cash and cash equivalents, certificates of deposits, commercial papers, bank deposits, and treasury bills and sells them to investors as shares.

Definitions

  • Commercial papers are unsecured short-term debt instruments issued by corporations. They are used by corporations to finance short-term liabilities.
  • Certificates of Deposit are savings that earn interest on a lump sum over a fixed period. They offer a higher interest rate than savings accounts.
  • Treasury bills are short-term debt instruments issued by the government.

Let us unpack how MMFs work. Let us say a government or corporation needs to raise Ksh 1 billion for a project. They will approach a bank or corporation to lend them the money. The bank and other corporations issue money market instruments to raise money. Instruments issued include commercial papers, certificates of deposit, and treasury bills.

These investments are generally considered to be very low risk because the debt instruments are typically backed by the full faith and credit of the government or a large corporation. The instruments are then sold to investors as shares. Most of the MMFs have a net asset value (NAV) of Ksh 100 per share. Any earnings above the NAV are distributed to the fund’s investors.

MMF will pay you interest every day. Interest earned is deposited into the MMF account at the end of each month. Let us break down how interest is earned in an MMF. If you invest Ksh 100,000 in an MMF with an indicative return of 9.45% p.a., here is what you can expect.

 Interest earned per day is Ksh 100,000 * 9.45/100/365 = 25.80.

Interest earned per month (in this case, January = 25 * 31 = 802.60)

Less withholding tax on earned income = 802.60*15/100 = 120.39

Net earnings from MMF for January =802.60-120.39= 682.2

Use our Money Market funds calculator to get a better view of what the earnings look like .

Money Market Funds calculator

Money market fund fees

MMFs charge fees based on what they call the expense ratio. The higher the expense ratio, the lower the returns. If the expenses are high and the interest is low, it will eat into earnings. Before you select a money market fund, make sure you take into account the MMF expense ratio.

Money market funds are appropriate for:

  • Investors with short-term investment goals
  • Investors with a low tolerance for volatility
  • In need of a liquid investment

How can I invest in a money market fund?

In Kenya, you can buy MMFs from insurance companies such as Britam, Sanlam money market, CIC, Madison, or licensed companies. Before you select an MMF, consider the following:

  • Interest rate
  • Expense ratio and management fees
  • Risk rate, or the Sharpe ratio
  • Instruments that make up the fund as they determine the risk
  • Licensing and regulations
  • Minimum investment amount and additional deposit amount

Once you review the above, decide on the best money market fund to invest in. To invest in a money market fund, you can buy shares from insurance companies or companies offering MMFs. You will need the following documents:

  • An application form duly filled
  • Copy of your ID or passport
  • Proof of bank account information, such as a copy of your ATM card.
  • Passport-size photo

If you want to invest in MMF as a corporation, you will need the following documents:

  • Completed application form
  • Certificate of incorporation
  • Copies of ID for the signatories
  • Board resolution to invest in MMF
  • Proof of bank details
  • Passport photo size

How Can I Get my Money from a Money Market Fund?

You can get your money from a money market fund by withdrawing it.

If you want to withdraw the money, call up the money market fund’s administrator and notify them of your intention to withdraw. The administrator will send you withdrawal forms and request proof of your bank account information.

Most money market funds will be available in one or two working days.

How Long Should You Keep Your Money in a Money Market Fund?

Most money market funds have a stated maturity date, which is the date when the fund will be redeemed at par. However, other money market funds do not have a maturity date and can be held indefinitely.

So how long should you keep your money in a money market fund? It depends on your investment goals. If you need access to your money quickly, you may want to keep it in a money market fund with a short maturity date. On the other hand, if you’re aiming for stability and don’t mind leaving your money invested for a longer period, you may want to choose a money market fund without a maturity date.

Ultimately, the decision about how long to keep your money in a money market fund is up to you. Just be sure to carefully consider your investment goals before deciding.

Pros and cons of money market funds

Investors seeking higher yields than what traditional savings accounts offer have long turned to money market funds. These mutual fund products are typically overseen by asset management firms and aim to deliver moderate returns while still providing a high degree of safety. However, money market funds are not without their risks; below, we outline some of the key pros and cons of these investment vehicles.

PROS:

  • Higher yields than traditional savings accounts
  • considered to be a relatively safe investment.
  • can be used to diversify a portfolio
  • They offer high liquidity compared to a fixed deposit account.
  • offer high interest compared to a savings account
  • Investors can diversify their money.

CONS:

  • Fees and expenses can eat into returns.
  • Share prices don’t appreciate, hence no capital appreciation.
  • The returns are sensitive to interest rate fluctuations, and monetary policy.

As you can see, money market funds can be an effective way to invest for short-term financial obligations. They provide investors with the ability to earn a decent return on their investments in a relatively low-risk manner. So if you’re looking to invest in something relatively safe, but will still help you earn returns over the short term, then look into opening a money market fund.

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