Pros and Cons of Money Markets

We already know that money markets are amongst the biggest sectors within the fixed-income securities market. The money market is widely used by players such as banks, mutual funds, and even individual investors because it is a great alternative to park funds in the short term.

In this article, we will have a closer look at what the pros and cons of money market funds are:

Pros of Money Market Funds

Money market funds rank high on the preference list of many investors. This is because of certain advantages that these funds have to offer. Some of these advantages have been listed below:

1. Competitive Rates: Money market funds are preferred by investors because they provide one of the most competitive rates in the short run. Money market funds have short maturities from one day to one year.

   Most of the money in money market funds is invested in ultra-short-term securities. However, the return is almost comparable to a certificate of deposit where money has to be locked in for the long term. For most investors, money market funds allow them to earn the best possible savings rate while keeping their funds liquid.

2. Liquidity: Money market funds are amongst the most liquid securities in the world. They can be instantly converted into cash without any significant loss of value. This quality attracts many investors since they can park the funds here for the short term and can liquidate this money as soon as they want to make any other investment.

3. Safe: The money market is a safe haven to park the money for a short-term period. Money markets are not volatile like stock markets. Money market funds usually invest their money in safe investments such as treasury bills, certificates of deposits, etc. Hence, the probability of any loss of value is quite less.

   Also, money market instruments do not face a significant drop in valuation in the event of a recession or a bear market. This is another reason why they are preferred over other financial instruments.

4. Variety: There are several types of money market funds available across the risk-return spectrum. This means that investors can choose a fund that works best for their risk appetite. Investors do not have the flexibility to make such decisions while investing in other short-term securities. This is one of the reasons that they prefer money market funds over other funds.

Cons of Money Market Funds

Money markets funds are also disliked by investors because there are some disadvantages associated with these accounts. The details of these disadvantages have been mentioned below:

1. Variable Returns: Money market funds park their investments in very safe government and commercial securities. However, a lot of the time, investors want to obtain a higher rate of return as compared to a certificate of deposits. Hence, in order to obtain this extra return, competition compels money market funds to invest in riskier bonds that have high yields. This means that it is possible that in some cases, money market funds will give a poor return.

   It is also possible that the return may be negative even though such a situation is extremely unlikely. Hence, when investors choose money market funds, they have to forego the peace of mind which is associated with having a fixed rate of return.

2. Lack of Insurance: Funds invested with banks in savings and deposit accounts are insured up to a certain amount. This means that the funds are safe even if the bank goes out of business. This level of safety is not available in money market funds.

   Money market funds are not insured by government regulators. Hence, investors have to assume the full risks of the actions of the fund. This lack of insurance makes money market funds a lesser attractive proposition.

3. Management Expenses: Money market funds are like mutual funds. This means that there is a management team that decides about how the money should be deployed amongst various short-term securities.

   From an investor’s point of view, the existence of a management team means that they will have to pay a management fee. Now, the problem with money market funds is that the return earned itself is quite low. If management fees are added on top of these low returns, the investment may not seem worthwhile.

4. Minimum Amount: A lot of money market funds are structured in a way that they pay a lower amount in returns to people who invest small sums of money.

   The percentage of returns has been structured to increase along with an increase in the sum of money invested. The existence of such a structure puts retail investors at a disadvantage. Hence, they often prefer to keep their investments out of the money market.

Hence, it can be said that money market funds are a very flexible tool at the hands of the investor. Unlike other short-term investments, investors can choose their own risk-return appetite. Although, they must be aware that funds that provide the best returns may not necessarily be the best investments.