Money Market Funds: What They Are, How They Work & More

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Investors might mint money through stock market but they carry higher risk. If you are searching for some short-term debt funds, money market funds work pretty well. This financial instrument is considered safe and is regulated by the government. In this blog, we discuss about money market funds in detail, their types and what you should know about them before investing.

What is a Money Market Fund?

Money Market mutual funds are type of debt funds. They allocate funds across different money market instruments, aiming to deliver reasonable returns within a year while ensuring strong liquidity. The average maturity of these funds is one year.

Features of Money Market Mutual Funds

When considering investment options, money market funds stand out due to their unique characteristics that make it both stable and profitable for investors. Money market funds provide a combination of safety, liquidity, and yield potential that makes them appealing short-term investment choices. Here are some of the key features:

1. Enhanced Liquidity: Money market mutual funds allow investors immediate access to their money. Leading funds allow redemption of shares at any time, making them well-suited for use as an emergency cushion or bridging short-term cash needs. Meanwhile, income potential and preservation of capital are made possible through investments in high-quality, short-term debt securities.
2. Better Returns: Money market mutual funds tend to yield better returns than at a traditional financial investment. Return on this investment is usually a bit higher than that of a fixed or recurring deposits, which can be attractive to investors who want a better yield.
3. Low Fees: Low costs are involved with the money market fund, and the investors pay meagre exit fees. The fees to get in and out of those funds are quite low, meaning investors keep more of the money they make.

Also Read: Best Investment Plans for Long Term in India

Types of Money Market Funds

Money market instruments are those securities which have maturity period of not more than one year. Following are some money market instruments in India:

1. Treasury Bills (T-Bills) - Sold by the Government of India for periods ranging up to 365 days are low risk, low return instruments. They are sold at a discount to par and redeemed at par.
2. Certificates of Deposit (CDs) - Fixed deposits of scheduled commercial banks. Unlike fixed deposits, CDs are transferable and cannot be withdrawn before it matures.
3. Repurchase Agreements (Repos) - Temporary financing instruments under which one party sells a security to another party with a agreement to repurchase the same security on a stated future date. Commonly used between banks and RBI or interbank.
4. Commercial Papers (CPs) - These are a kind of short term unsecured promissory notes issued with a corporate or other creditworthy lender. They are sold under their face value and redeemed at par on maturity.
5. Call and Notice Money - Inter-bank lending for very short period borrowing such as overnight borrowing. It is used both a reference rate and as a charge rate is call money while for borrowing for a period of 2–14 days is a money notice.

How Does Money Market Work?

Money market funds are subject to SEBI's regulatory framework and are categorised as debt mutual funds. They mostly make investments in short-term, premium debt instruments that have maturities of no more than a year. This is how they work:

1. Structure and Regulation
   These funds combine investor capital into a single portfolio and are run by asset management companies in accordance with SEBI's mutual fund regulations.
2. Investment Instruments
   Assets are distributed among commercial papers, repurchase agreements, certificates of deposit, and Treasury bills by fund managers.
3. Objectives and Returns
   Depending on the current market interest rates, the objectives are modest returns, high liquidity, and capital preservation.
4. Unit Purchase, Redemption, and Liquidity
   On any given business day, investors purchase redeemable units. Within a few business days, the registered bank account typically receives the redemption proceeds. Withdrawals from certain funds may be restricted for a predetermined amount of time.
5. Taxation and Suitability
   Profits earned on money market mutual funds is taxed as per current taxation rules. These funds are ideal for investors looking to park excess funds in a low-risk, short-term manner.

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Money Market Fund Regulation

The Reserve Bank of India regulates the majority of money market-level operations in the Indian system. The Bank runs its business in a way that is intended to support monetary stability as well as the soundness and effectiveness of the financial system. Its primary regulatory responsibilities include:

• Control Over Monetary Policy:  The RBI sets key interest rates, including the repo and reverse repo rates, which affect lending and borrowing rates and, consequently, the amount of money in circulation in the economy.
• Liquidity Management: Through Open Market Operations (OMOs), the RBI purchases and sells government securities to increase or decrease the amount of liquidity in the system.
• Ensuring Stability: To avoid upsetting financial stability and maintain market stability, the RBI oversees and regulates banks and other financial institutions.
• Liquidity Adjustment Facility (LAF): This serves as a tool to assist financial institutions in managing their short-term liquidity requirements while preventing unanticipated overages or deficits in reserves.
• Market Development: The RBI creates explicit rules for fair and transparent trading and launches new, creative monetary instruments.

While mutual funds, including those that concentrate on money market instruments, are governed by the Reserve Bank of India (RBI), It is in charge of the larger money market. SEBI enforces stringent regulations to safeguard investors and improve market clarity.

Advantages and Disadvantages of Money Market Funds

Money market funds are favoured by investors looking for safety, easy access to funds, and moderate returns. The table below highlights the main benefits and drawbacks of these funds:

How Safe is Money in a Money Market Fund?

If you're thinking about including money market funds in your Mutual fund portfolio, money market funds in India invest in short-term, low-risk securities like commercial paper and Treasury bills with the goal of maintaining capital and offering high liquidity.

Because of SEBI regulations and investments in high-quality securities, they are regarded as safe; however, they are not risk-free because they are still susceptible to inflation and changes in interest rates. The modest returns prioritise stability overgrowth.

Taxation Rules of Money Market Mutual Funds (FY 2025)

Taxation on money market mutual funds has changed especially for investments made after April 1, 2023. The table below captures these key changes, helping investors see how their money market funds investments are taxed.

• Money market funds are classified as debt mutual funds for tax purposes.
• No indexation benefit is available for units purchased on or after April 1, 2023.

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Conclusion

For short-term investments, money market funds offer a secure and liquid alternative. They protect capital while providing modest returns. You can effectively increase your savings with a DBS Treasures Premium Savings Account to go along with your investments. When combined, they provide a comprehensive approach to wealth management.

Disclaimer: This information is not intended to be interpreted as financial advice; rather, it is provided for informational purposes only. A financial advisor should be consulted before making any investment decisions.