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Is a money market fund right for you right now?

Money market unit trusts have become popular as they appear to provide a safe, secure and reliable haven for your investments. During times with extreme volatility, you may be comforted knowing that your hard-earned rands will earn interest, as you put your money in and you get it back with a sliver more. But, no investment is risk free, so the question is – are money market funds right for you, now?

Many investors have flocked to the safe havens of money market and income funds due to South African equities delivering lean pickings over recent periods.

Data by the Association for Savings and Investments South Africa (Asisa) released in February mirrors this sentiment, showing that that income funds posted real returns of 4% in 2018, and in the last three years, they have performed well, with higher real returns than low-equity cautious funds. 

But the reality is that investing 100% of your assets in rand-based money market funds may not be right for you, especially if you are investing for a long-term goal like retirement or for your child’s education. And money market funds are not entirely risk free.

The pros of money market funds

Money market unit trusts are great for money in transition, or for a short-term savings or emergency plan. They are an effective parking place for your money. They allow you to store money that you will use in the near future, while getting some returns. 

One of the benefits of money market funds is that your money is easy to access. They are more liquid than a fixed-deposit account with a bank, and don’t hit you with penalties that often apply when you request access to your money from a fixed deposit.

A second benefit is that your eggs are not all in one basket. A money market unit trust has investments across lots of issuers, whereas a deposit is only with a single bank. Even though the bank does guarantee your deposit, banks sometimes fail, so although your risk is low, it is also concentrated. 

The risks of investing in a money market fund 

It is a misconception that money market funds are risk free. Investors in money market funds are exposed to a number of risks, which can result in real (and, in extreme situations, even nominal) capital losses. The three major risks include negative real interest rates, credit risk and liquidity risk.

Inflation is the primary reason why money markets are not suited to individuals with a long-term horizon. Specifically, if the rate of inflation exceeds after-tax interest rates, then the spending power of your money will decline over time – this is called negative real interest rates.

A money market fund is unable to provide protection from the erosion of capital should policymakers choose to administer negative real interest rates. If you had, for example, invested in a money market fund in Zimbabwe years ago, you wouldn’t have lost a single Zimbabwean dollar, but you would have lost the entire spending power or real value of your investment.

The second reason investors may not want to invest in a money market is credit risk.

Money market funds invest in debt instruments. If the issuer of the debt instrument goes bankrupt, investors would likely bear a loss. Some funds, such as the Allan Gray Money Market Fund, try and buffer against this risk through diversification of issuers.

Lastly, extreme circumstances can heighten liquidity risk. If, for example, a money market fund receives a request for an extremely large withdrawal amounts from its investors, then it may force the fund to sell a type of financial instrument commonly used by money market funds called long-dated paper, which could incur a loss for the fund and its investors.

While the risks apply mostly to extreme circumstances, such as the financial crisis of 2008, it is important to be aware that money market funds, like all investments, are not entirely without risk.

If you are worried about the risks of the money market fund you are considering, ask your investment manager how the fund is positioned to deal with them, and what the plan is to protect investors’ capital.

As always when making a big investment decision regarding your money, consider speaking to an independent financial adviser who can help you make the right decision for your goals and risk appetite.

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