What you need to know about using money market fund for short term saving
As the banks and insurance companies lower their interest rate on their savings product, it is only natural that we would want to look elsewhere for higher returns on our short-term savings.
In my previous article: Ultimate Short-Term Saving Guide, we’ve explored a comparison, the pros and cons of each short-term saving instrument.
In this article, I would like to share with you why I am using a money market fund to park the majority of my short-term savings and what do you need to know about it as an instrument class.
What is a money market fund?
A Money Market Fund is an investment fund that invests in highly liquid, short-term instruments. The instruments that the fund would invest in usually includes high-credit-rating debt-based securities with a short-term maturity.
Essentially, what the fund does is that they take your money and lend it to established companies that are deemed to be safe.
Typically, the duration of the loan last about 1 to 2 years and at the end of the duration, the borrower will pay back the loan amount in full.
The way you profit from such an arrangement is of course the interest that was earned from the loan itself.
What’s the risk?
As with all forms of investment, there are risks involved with such an arrangement.
The key risk that you are looking at in the area of a Money Market Fund comes in two forms.
Credit Risk: This is the risk of the borrower being unable to make repayments on the loan. When that happens, you run the risk of losing the capital that was used to lend the company.
Volatility Risk: This is the risk of having an increase or decrease in the price and value of your investment.
As debt-based securities are sensitive to the interest rate environment, the price of your money market fund would increase or decrease depending on the changes to the interest rate.
Is this an issue though when it comes to the use of Money Market Fund, the answer to this is no.
Let’s go through this one by one.
For the area of credit risk, as the money market fund invests in multiple investment grade debt securities, the risk of investing in a borrower that is unable to make good on their repayments is very low.
Even if that happens, because the fund invests in multiple investment-grade debt securities instead of only one, the impact of one non-repayment is mitigated as the performances of other debt securities will offset the losses of the debt security that went bad.
For the area of volatility risk, given the nature of debt securities, fluctuations of prices are not a concern to you if you intend to hold the security until the debt securities mature.
This is because when the debt securities mature, the lender will receive the full amount of the loan that was initially provided to the borrower. As such, as long as you can hold the fund for a period longer than the weighted average maturity of the fund, short-term price changes is of no concern to you.
The weighted average maturity is essentially the weighted average amount of time until the debt securities mature, which usually is shorter than 2 years for money market funds.
What’s the return?
As the common saying goes: “low-risk low return, high-risk high return”, when it comes to the return of money market fund, a reasonable range of average returns that you can expect would be 1.0% to 2.5% per year.
Granted, the average standard deviation of returns for a money market fund is ±2%. As I mentioned earlier, as long as you can hold on to the fund for a duration longer than the average weighted maturity, such deviation of returns are of no concern to you.
Why do I prefer this over other instruments?
In my opinion, a money market fund is better than…
A savings account (multiplier) as the interest earned on a Money Market Fund is essentially effortless as compared to a savings account where you have to ensure that certain criteria are being met.
An endowment and fixed deposits as the money that are invested into the fund can be withdrawn as and when necessary – granted you run the risk of price volatility if the duration is too short.
Singapore Government Savings Bonds as the return from the Money Market Fund is higher if we're looking at 2-5 years period.
How can you go about investing in these
There are two ways that you can get involved with Money Market Funds, the first is to do it yourself by investing through a broker like FSMone.
The second is to invest through a Robo-advisor that manages their own Money Market Fund-of-Funds (a.k.a Cash Management Accounts) – basically, they are a “Fund” that invests in multiple Money Market Fund.
When it comes to making your decision, the first step to making a decision is of course finding out what type of Money Market Fund you want to park your savings in.
The second step is to identify the different platform that carries the exact fund that you are looking for.
The third step is to select the broker that you prefer to work with given the cost and support.
Now, for obvious reasons, I cannot and will not share with you the money market fund that I am using in this article, if you are interested to find out more you can either contact me directly or join the telegram channel to find out.
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This article is meant to be the opinion of the author
This article is for information purpose only
This article should not be seen as financial advice
The information that was presented in this article are taken from the websites of the respective named providers
This advertisement has not been reviewed by the Monetary Authority of Singapore