|When to use a Money Market Fund?
With more recent equity market fluctuations and uncertainty, money market unit trust funds have become synonymous with safe, secure and reliable investments, but there are other risks to consider and therefore it must be carefully considered under what circumstances should you use them?
In simple terms, the money market is where companies, governments and banks raise money by getting short-term loans from investors. In practical terms, all transactions are done electronically through a network of buyers and sellers, sometimes in auctions run by the banks, and there is no central or physical location where the money market exists.
Money market unit trusts are a good tool to use for money in transition or for short-term savings.
“They are an effective ‘parking place’ for your money. They allow you to store money that you will use in the very near future, while getting some returns and keeping the money out of your normal transactional bank account.
Money market funds are quite similar to a fixed deposit account at a bank, but come with some advantages.
First, you can cash out whenever you want, whereas with most fixed deposit accounts, you are locked in for a specified period where you may not withdraw your money immediately. A money market unit trust is more liquid, which is something you should consider when comparing its returns to a fixed deposit from a bank.
A second benefit is that your eggs are not all in one basket. A money market unit trust has investments across lots of issuers, whereas a deposit is only with a single bank where you make the deposit. Even though banks guarantee your deposit, they do sometimes fail. The risk is low, but it is also concentrated.
The downside of money market investments is the silent money killer – inflation. The returns of a money market unit trust often do not keep up with inflation over the long term.
If inflation exceeds the yield, you may not lose a cent from the balance you see on your investment statement, but each cent will buy less as inflation causes prices to rise, the longer you keep your money in the unit trust.
Put differently, money market unit trusts are usually not appropriate for long-term investing, such as saving for retirement or your child’s education, because the risk of inflation is too high, especially in South Africa.
It is therefore critical that you carefully consider a number of factors before splitting your investments into different funds. Your overall investor risk profile needs to also be weighed up against the purpose of the investment and the time horizon in respect of your individual needs. Nothing can be done in isolation, your life and the kind of life you want to live, now and in the future, must match the ultimate investment choices you make.