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Pros and cons of money markets

Oct 06 2010 14:44
There are many advantages to money market funds, which is why they are so popular with investors.

In the risk spectrum, money market funds are the lowest risk unit trust sector.

Capital is safer than in a bank (because it’s spread over a number of banks) and the interest earned with be higher.

Compared to equity and balanced funds, management fees are also low. And the investor’s cash is readily accessible from the fund should it be needed.

The funds are therefore a safe and secure parking bay as part of a bigger investment plan. But as with all investments there are some risks as well, even with money market funds.

One is that a cautious investor might keep his money in a money market fund and miss out on higher returns in other unit trust sectors.

That’s why we always emphasise a diversified investment portfolio.

The other is that investors in a money market fund might not get a real return. This has been the case in the past when inflation was higher than the return on a money market fund.

While not a risk, investors need to remember that interest earned from a money market fund (as with interest from any other unit trust fund) will be taxed at the marginal rate.

Dividends in an equity fund are tax free, though the investor is liable for capital gains tax when withdrawing from the fund.

Money market funds are also subject to interest rate risk. When interest rates go down so do returns. However, a good money market fund manager will protect the investor from interest rate risk, for instance by correctly anticipating a cut in rates and locking investments in at the higher interest rate.


 - Finweel
 

investment  |  interest rates  |  money market
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