But who should be using money market funds and why?
Unfortunately many retail investors are in these funds for the wrong reasons, often because of an obsessive fear about losing capital.
Essentially, money market funds are a fairly short-term investment. This is how institutions use them, parking excess cash to get better rates than in the bank for a future project, perhaps a possible acquisition or capital spending project.
Retail investors tend to scamper into money market funds, or get put there by financial advisers, when they are nervous and unsure about financial markets. There’s merit to this, money market funds are the lowest risk unit trust sector and have the lowest management fees.
But often many retail investors just stay in money market funds because this makes them feel safe, instead of drawing up a diversified investment plan.
At the time of writing about a third of the retail investors’ market was in money market funds, according to figures from the Association for Savings and Investment SA (Asisa).
Money market funds are a comfortable investment but over the longer term they will not always provide very good returns, being largely dependent on the interest rate.
At times money market funds have not provided a real return, so investors’ money is being eroded compared to the rate of inflation.
As part of a diversified investment portfolio, money market funds are excellent. An investor might want part of the portfolio to be in cash and might want to earn some income and this is where money market funds can be used very effectively.
Also in times of market uncertainty, for instance when the equities market is volatile and investors are nervous about a market crash.
But then it’s a short-term investment as the investor formulates an overall view and perhaps plans a new investment strategy.
Money market funds can also be used if there’s a particular investment goal in sight. But not for more than a few years at the most.