Money Market Funds: For A Safe Bet

Each month, I deposit my salary in my savings bank account and use a portion of this for my monthly expenses. Is there any way in which I can earn higher returns? I may need to withdraw my investments at short notice. - Kedar Pradhan 

Yes there is certainly a way in which you can earn higher returns than the interest you receive on your savings bank account! You could invest in money market mutual funds for higher returns. Money market funds are considered to be very safe and they carry the lowest risk as compared to other types of open-ended funds. Th ese open-ended debt funds generally invest in fi xed income securities such as commercial papers, certifi cates of deposits, treasury bills and corporate bonds which generally mature within 90 days and hence are very predictable in their returns. Consequently, unlike their longer-duration counterparts, money market funds are not very sensitive to fl uctuations in interest rates. Furthermore, money market funds generally invest the majority of their portfolios in highly rated fi xed income instruments and hence have low default risk.

These funds usually have no exit loads. Therefore, you can redeem your investments at any time. Generally, when you redeem your investment in a money market fund, you will receive the amount the next day if your request has been submitted before the cut-off time. At the end of March, the yields off ered by money market funds were between 9 per cent and 10 per cent. Th ese funds generally have expense ratios lower than 1 percent. Even aft er expenses have been accounted for, the yields off ered by money market funds are nearly double the rates on savings bank accounts. The rates on savings accounts at most major banks are only around 4 per cent while a few private sector banks off er rates as high as 6 per cent if your balance exceeds `1 lakh.

The NAVs of some money market funds dipped briefl y in July 2013 when the RBI imposed emergency liquidity tightening measures to stabilise the currency. These measures led to a spike in short-term yields which dragged down the returns of some money market funds for a couple of days. Nevertheless, as shown in the chart, the NAVs of these funds quickly recovered. This was virtually the only month in the last fi ve years in which this phenomenon occurred.

In spite of the marginal setback last July, investors in money market funds eventually benefi ted from higher accrual returns as carry yields increased. As shown in the table below, the weekly dividend options of some

[PAGE BREAK]

money market funds have generated returns between 7 per cent and 8 per cent during the last year (even after deducting dividend distribution tax).

Money market funds may also be more tax effi cient than savings accounts. If the interest you earn from the money in your savings account is greater than `10,000, then this will be taxed according to your tax slab. However, as shown in the table below, if you invest in money market funds, you can save tax by choosing to invest in dividend options if you fall in the highest tax bracket.

If you had invested in the Weekly Dividend options of money market funds during the last year, the post-tax returns on your investment would have varied between 7 per cent and 8 per cent (net of dividend distribution tax or DDT).On the other hand, if you had invested the same amount in a savings bank account, the post-tax returns from your investment in your savings bank deposit would have been signifi cantly lower, as shown in the chart. (Note that the post-tax returns have been calculated on the assumption that you are in the highest tax slab).

Consequently, you may be better off by investing a portion of your salary in money market funds each month.