When talking about investment options, money markets often come up as a low-risk investment option for either risk-averse individuals or one’s who are relatively new to investments. What are money markets and what are the risks and benefits associate with this investment option? This article seeks to provide answers to the posed questions as well as increase our knowledge on money markets.
First, money market funds vs. money market accounts, is there a difference? Money market funds refer to unit trusts, otherwise known as mutual funds that investors use to invest in low-risk, short-term debt instruments. On the other hand, money market accounts are individual accounts that an individual uses to access money market funds. When choosing which money market fund to invest in, it is critical to check performance of the institution offering the fund as earnings differ for different fund providers.
Risks associated with money market funds
As with any other investment option, money market funds also have associated risks although very minimal due to its nature and regulations governing them.
- Have higher expenses. Money market funds often have withdrawal fees, management fees and transfer fees. If the institution one invests in has high fees, then it may prove to not give returns as expected.
- A nations economic collapse would lead to loss of investment. Seeing as it is rare for economies to collapse, then this instance is relatively rare. However, in the case that a whole economy collapses, then the investment would result in a loss.
Benefits of money market funds
The benefits of a money market fund far outweigh risks associated with it.
- High liquidity. Taking out your money from a money market fund typically takes few days, making them very liquid investments. It is due to their liquidity that they are often recommended as emergency funds.
- Higher interest rates. Money market funds often have interest rates from 5-10%. This enables a substantial return on investments while keeping well above inflation rates that tend to eat into the value of money.
- Relatively low investment deposits. In Kenya, one can invest in money markets with funds from as low as Ksh.100. This enables low-income earners access investment options that would typically be a reserve of a few.
- Low risk. Money markets are often regulated by governments through financial institutions. They also invest in low-risk, short-term investments such as commercial paper and treasury bills. In Kenya, money market funds are regulated by Capital Markets Authority that ensures fund managers do not invest more than 25% in one area.
- Have a compounding effect. Interest in a money market is earned monthly. As the money sits in the money market fund, the interest earned is added to the initial investment hence the principal amount changes as interest earned is re-invested.
- Ideal for short term goals. Due to its high liquidity and high interest rates, money markets are ideal for helping achieve short-term goals. This is because it offers a buffer against inflation shocks while ensuring accessibility to funds.
The article has highlighted benefits and risks associated with money markets. It is aimed to equip its readers with information to better understand money markets.
-By Jane Mwangi