Investors with a low-risk profile are usually on the lookout for investm ent options that will offer them decent returns as well as liquidity. To that effect, money market funds are one of the most preferred options among investors when it comes to short-term debt investing. This article will cover everything you need to know about money market mutual funds.

Money market funds^* (MMF) are a type of mutual fund  that invest in highly liquid, short-term, fixed-income debt securities such as cash and cash equivalents, Treasury bills, commercial papers, certificate of deposits (CD), etc. The average maturity of a money market fund is 1 year or less, which protects them against interest rate risk.

Following are some of the most popular money market mutual funds in India:

1. Treasury bills (T-bills)
   Treasury bills (T-bills) are issued by the Government of India for a period of up to 365 days. As these are government-backed, they are considered to be one of the safest instruments. However, the rate of return, also known as the risk-free rate, is among the lowest compared to other money market instruments.
2. Commercial papers (CP)Commercial papers are unsecured, short-term promissory notes with a high credit rating and are issued by companies and financial institutions. These unsecured instruments are usually issued at a discounted rate  and can be redeemed at face value.
3. Certificate of Deposit (CD)CDs are term deposits such as fixed deposits (FD) that are offered by scheduled commercial banks and do not have the option of premature redemption. Thus, one of the major differences between FDs and CDs is that investors are not allowed to withdraw the latter before maturity.

Following are some of the benefits of MMFs^#:

1. LiquidityOne of the key benefits of money market funds is that they offer high liquidity. This is because money market funds invest in securities that have short maturities. An investor can usually retrieve their capital from a money market fund in one to two business days. 

2. Higher yieldsOther than safety and liquidity, money market funds also have the potential to offer higher returns than traditional cash equivalents such as savings accounts.
3. Risk managementMoney market funds entail low to moderate level of interest rate risk as they hold securities that mature within a year. Fund managers tend to invest in instruments that have a good credit rating as their prime focus is capital protection. Thus, money market funds carry relatively low risk.
4. Steady returnsMoney market funds generate near-steady returns through cycles of interest rate tightening and easing as fund values do not change much in response to fluctuations in the financial markets. The low credit risk also ensures that money market funds are relatively less volatile than most fixed-income securities.

Following are some important aspects than an investor must consider before investing in money market funds:

1. Risk
   Money market funds are subject to interest rate risk, reinvestment risk, default risk, and credit risk. Interest rate risk refers to a drop in the price or value of the underlying security with a decline in interest rates. 

2. Return
   Money market funds have the potential to offer higher returns than a traditional savings account. However, investors must note that the returns are not fixed as with a savings account. The  net asset value (NAV) of the fund fluctuates with a change in the overall interest rate regime.
3. Expense ratioSince money market funds do not have the potential to offer significantly higher returns, the expense ratio plays a significant role in determining an investor’ earnings from the fund. Ideally, an investor should look for funds with lower expense ratio to maximise their earnings.
4. Investment horizonMoney market funds are ideal for investors with short investment horizons, i.e. up to a year. These funds can help investors park their surplus cash while maintaining liquidity.
5. TaxIt is important to understand the taxation on a given security before investing in it. Money market funds are taxed like debt funds and capital gains on debt mutual funds are taxable.

In the case of money market mutual funds, the following taxation rules are applied:

1. If the holding period is up to three years, then the gains are classified as short-term capital gains (STCG). The tax on STCG is as per the income tax slab of the investor.
2. If the holding period is more than three years, then the gains are classified as long-term capital gains (LTCG). The applicable tax rate for LTCG is 20% with indexation benefits.

Money market mutual funds could be the ideal investment avenue for the following investors:

1. Investors who wish to park their short-term surplusAs money market funds provide high liquidity, they are ideal for investors who wish to park their surplus income for the short-term, i.e. ranging from a month to a year.
2. Investors on the lookout for an alternate short-term savings securityMoney market funds usually offer greater returns than traditional savings accounts as these funds generate income through capital gains plus interest payments.
3. Investors who want regular income for a short-term
   Money market mutual funds offer regular income to investors with the benefits of liquidity and stability. Risk-averse investors can allocate a part of their corpus to money market funds and use the SWP option (systematic withdrawal plan) to create a regular stream of income.
4. Investors who wish to use it as a medium to route their investments in equity mutual funds
   An investor can also use these funds as a medium to route investments in hybrid or equity funds through the STP (systematic transfer plan) route.

Follow these simple steps to invest in money market funds:

1. Create a mutual fund account with a fund house or an AMC (asset management company)
2. Complete your KYC (know your customer) formalities.
3. Input the necessary details, as required.
4. Identify the fund(s) you wish to invest in based on your financial goals, investment horizon, risk tolerance, etc.
5. Select the apt money market fund that aligns with your portfolio and transfer the required amount.
6. As an investor, you can also make a standing instruction with your bank in case you want to invest via the SIP mode. 

Money market funds are ideal for investors who have a low risk tolerance. As an investor, you must look for funds with a good track record and historic growth rate. One must also pay heed to the investment strategy of the fund manager and ensure that they stick to securities that have a good credit rating. Happy Investing!

^*Mutual fund investments are subject to market risks. Read all scheme-related documents carefully

^#The benefits are indicative in nature and the same may vary depending upon various market-linked factors.