If you have money in an emergency fund, savings account, or spending fund, money market funds can help you receive a higher return on your investment. In this blog, we will explore how to diversify your portfolio with money market funds.
Money Market Funds: What Are They?
One kind of mutual fund that makes investments in highly rated short-term debt securities is called a money market fund. They produce revenue, but there is little to no capital growth. In the 1970s, money market funds were created as an alternative to interest-bearing bank accounts, offering a little better income.
The return on money market investments is usually poor, sometimes in the single digits. The risk to principal is typically very modest in comparison to stocks or corporate debt problems. However, when it comes to money market funds, investors must consider a number of advantages and disadvantages.
Money market fund benefits
Low risk and short duration
Investors may find the money market to be a safe refuge when the stock market is incredibly unpredictable and they are unsure of where to put their money. As previously said, compared to their stock and bond equivalents, money market funds are sometimes regarded as less hazardous.
This is due to the fact that these funds generally make investments in low-risk securities including short-term commercial paper, Treasury bills, and certificates of deposit (CDs). Additionally, a money market fund’s exposure to interest rate risk is limited by the short maturities of these assets. Additionally, even though investors often receive a low, single-digit return from the money market, that can be very alluring in a turbulent or declining market.
The process of diversification
A money market fund, like the majority of mutual funds, provides immediate diversification across a variety of securities. Choosing and investing in different money market assets one at a time is not necessary for investors. For any portfolio, diversification is a crucial safety measure.
Security and Stability
One of the least volatile investment options is a money market fund. This trait can be helpful in compensating for the higher volatility of any stock and bond assets you may have. Additionally, when no other option is practical, they provide you with a safe, short-term investing option. A money market account is a bank-opened account that pays interest. A mutual fund is a money market fund.
High liquidity
Generally speaking, money market funds avoid investing in stocks with little trading volumes or minimal investor interest. Instead, they mostly invest in assets and/or businesses that are in relatively high demand (such short-term T-bonds and T-bills). This indicates that they are typically quite liquid, making it very easy for investors to buy and sell them.
Possible Tax Efficiency
Money market fund investors may discover that certain fund investments are exempt from both federal and possibly state income taxes on interest payments.
Money Market Fund Drawbacks
Inflation Risk
An investor is effectively losing purchasing power annually if their money market fund is yielding a 3% return and inflation is hovering around 4%.
Costs Can Have a Negative Impact
Even minor yearly costs might consume a significant portion of the revenue when investors are only receiving 2% or 3% from a money market fund. Money market investors may find it much harder to keep up with inflation as a result. The detrimental effect that fees have on returns varies by fund.
Absence of Federal Insurance Protection
The Federal Deposit Insurance Corporation (FDIC) normally insures a money market account opened at a bank for up to $250,000 per depositor. The Securities Investor Security Corporation (SIPC) offers investors some level of financial security, but the FDIC does not cover money market funds.
Higher Yields Could Be Dangerous
Fund managers may choose to take on more risk in order to provide their clients with larger returns, even though money market funds typically invest in government securities and other assets that are seen as safer than stocks and bonds. Keep in mind that a fund’s return from the prior year does not always predict its potential return in the next one.
Low Returns Indicate Missed Chances
With time, the average return on equities, including data from recessions, has been between 8% and 10%. An investor may be losing out on a higher rate of return if they choose to invest in a money market fund, which frequently only yields 2% or 3% because of the fixed income nature of its investments. This can significantly affect a person’s capacity to accumulate wealth over time.
The Bottom Line
Money market funds, like any other investment, offer advantages and disadvantages that should be carefully weighed before purchasing. Money market funds provide a reliable and secure investment option for those seeking to make short-term investments, but they are not the best choice for long-term investing because of their poor yields and lack of capital appreciation, and with JS Bank you can diversify your portfolio even further.
