Money Market Funds, Explained Simply

Under SEBI rules, these funds invest in money market instruments with a maturity of up to one year. These include treasury bills issued by the government, commercial paper issued by companies, certificates of deposit issued by banks, and short-term repo arrangements.

Because these instruments are short-term, their prices do not move much when interest rates change. Our page on debt funds explains the wider family these funds belong to.

The instruments a money market fund holds pay interest, or are bought at a discount and repaid at full value on maturity. That income flows into the fund and slowly raises the NAV every day.

When an instrument matures, the fund reinvests the money in new ones at current rates. Our page on how mutual funds make money explains this in more detail.

Liquid funds hold instruments maturing within 91 days. Money market schemes can hold instruments up to one year. That longer reach means they may earn a little more when rates are steady, but their NAV can move slightly more when rates change.

Liquid funds also offer quick redemption features at some fund houses. Our page on liquid funds explains them.

Overnight funds hold instruments maturing in one day, which makes them the steadiest debt funds of all, with very little credit or interest rate risk. They usually earn less than these funds.

Our page on overnight funds explains when they fit.

Ultra-short duration funds are defined by the average duration of their portfolio rather than the maturity of each instrument. They can hold some instruments longer than one year, as long as the portfolio average stays within limits.

Our page on ultra-short and low duration funds compares these categories.

These funds are commonly used for money needed in roughly three to twelve months. For a few days or weeks, liquid or overnight funds are more suitable. For a year or more, short duration funds may also be considered.

Our page on short-term investment options lays out the choices by time frame.

Credit risk: if a company whose commercial paper the fund holds fails to repay, the fund NAV can fall. This is why credit quality matters.

Interest rate risk: small, because maturities are short, but not zero.

Liquidity risk: in rare stress periods, some instruments can be harder to sell quickly.

Our page on risk and volatility explains how to think about these.

Look at the fund fact sheet to see how much is in treasury bills, bank certificates of deposit and top-rated commercial paper. A fund holding mostly A1+ and sovereign instruments carries low credit risk.

Our page on credit ratings in debt funds explains what these ratings mean.

Some investors keep part of their emergency fund in a liquid fund for quick access and part in a money market fund for slightly longer needs. The part you might need within days is usually better in a savings account or liquid fund.

Our page on building an emergency fund explains how to split it.

When investing a large lump sum gradually into equity funds, some investors park the money in a liquid or money market fund and transfer a fixed amount into equity every week or month.

Our page on STP explains how this works.

A savings account gives instant access and is very simple. A money market fund may earn more on money you will not need for a few months, but redemption usually takes a working day or so, and the value can move slightly.

Our page on mutual funds versus a savings account compares them.

A fixed deposit gives a known rate for a set period, but breaking it early may carry a penalty. A money market fund has no fixed rate and its return can vary, but you can usually redeem any working day without penalty after a short period.

Our page on liquid fund versus FD explains a similar comparison.

Because the return gap between short-term funds is small, costs matter a lot. A difference in expense ratio can take away much of the advantage of one fund over another.

Compare expense ratios carefully. Our page on expense ratio explains how they work.

Gains on money market funds are taxed under the rules for debt mutual funds, which depend on the rules at the time. We do not quote tax rates. A tax adviser can confirm your situation.

Our page on mutual fund taxation explains the general structure.

Suppose a family has set aside money for a child college admission payment due in eight months. Keeping it in an equity fund would be risky so close to the date. A savings account may earn little. A fund holding short-term, high-quality instruments can be a middle option for those eight months, with the money redeemed a few days before the payment. This is an illustration, not a recommendation.

Redemptions from these funds are usually paid within one working day after the request, depending on the cut-off time and the fund house. That is fast enough for planned payments, but not for a sudden emergency at night or on a holiday. Our page on the cut-off time explains how timing works.

• These funds hold instruments maturing within a year.
• They suit money needed in a few months.
• Risks are low but not zero.
• Check credit quality and costs.

We are distributors rather than investment advisers and we recommend no schemes. If you want help choosing where to park short-term money, get in touch.