When it comes to investing your money, you’ll probably know by now that you have numerous options to choose from. In fact, it can feel like a bit of a minefield and sometimes you may not know if you’ve made the right choice. Should you choose a bond fund, equity fund, property fund or a money market cash fund? Or any other type of fund? So, what is a Money Market fund?
When it comes to investing your money, you’ll probably know by now that you have numerous options to choose from.
In fact, it can feel like a bit of a minefield and sometimes you may not know if you’ve made the right choice.
Should you choose a bond fund, equity fund, property fund or a money market cash fund? Or any other type of fund?
So, what is a Money Market fund?
They are essentially unit trusts that aim to provide investors with an income from risk-free, short-term cash and cash-like holdings.
Some investors have been selling their share funds and have opted for security by pouring millions into these types of funds. In our experience, this type of investor will tend not to have a proper risk assessed portfolio, rather a collection of disparate investments, and may be doing it all themselves.
The money manager of their choice will place this money into bank deposits, certificates of deposit*, very short-term fixed interest securities and floating rate notes**.
Most Money Market funds require relatively low minimum investments – typically around £500. They are also quite low-charging, typically with no initial charges and an annual management fee between 0.25% and 0.50%.
So, in short, these funds are cheap, accessible and low risk. In these turbulent investment times, what could be better?
However, if you are paying an annual fee for a Money Market fund, it would be reasonable to expect that the fund manager would beat the return available from conventional, high street savings accounts.
Unfortunately, most Money Market funds aren’t performing better than traditional savings accounts!
Just take a look at their track record performance:
1 year – 3.8%
5 Year – 15.7%
10 Year – 41.2%
Put simply, leading savings deposit accounts would do similar or better!
So what is going on here?
The problem is that some funds are taking more risk than others, which drags the averages down. Conventional Money Market funds invest in deposit accounts and short-term, high-quality debt. But, lately, some funds have taken to investing in riskier assets such as lower-grade corporate (company) debt and longer-term loans.
The idea of course is to generate a better return. The downside is that defaults are occurring more frequently and with less liquidity (yet another repercussion of the credit crunch).
As an example, one leading fund has actually produced a negative (-3.9%) return over a year. This is worrying, since these funds are supposed to protect your capital.
So, taking the scope of returns into account, these funds actually seem quite expensive in terms of running charges. What’s more, the investment strategy of some funds is hardly low-risk and consequently are all exposed to some degree of market volatility.
In addition, it is difficult to determine the quality of the debt instruments your money is being invested in. US Funds have been feeling the impact of the subprime debt crisis for some time now, with falling interest rates putting pressure on returns. So the question is; will it soon be a similar story in the UK?
Since there are a number of market-leading, easy access savings accounts that are paying interest rates of 6 – 6.5% without any market risk at all, then if you are going to invest in a Money Market Fund, on paper it may NOT be the best option for your money.
* Certificates of deposit = A time deposit (i.e. a deposit with a specified maturity) made at a bank which pays fixed or floating rates of interest. The lender receives a certificate that a deposit has been made which can then be sold in the secondary market whenever cash is needed.
** Floating Rate Notes = Bonds and other debt instruments that carry a variable (i.e. floating) rate of interest, usually linked to a reference rate such as the LIBOR.
# Source: Investment Management Association, IMA. March 2008.
The Financial Tips Bottom Line
We have written many articles on the folly of ‘jumping ship’ and having no clear investment philosophy.
It really can’t be stressed enough – be an investor, not a gambler.
If you have a Money Market Fund, review this urgently. Contact your planner or adviserFree Reprint Articles, and ensure you are getting the most from your investments.