Why money market funds are good for short-term investments

Cash may claim to be king again as interest rates stay higher for longer than expected, but it faces a new challenge to its throne in the shape of money market funds . These may still be unfamiliar to many private investors , but their popularity has rocketed as they often pay more interest but with no more risk. Money market funds are giving government bonds such as US Treasuries a run for their money, too, offering higher yields, greater flexibility and more security. As yields hit 5 per cent, investors have piled in, with the total invested racing past $6 trillion. With instant access, diversification and little volatility, money market funds wear the crown right now. But can it last? Money market funds are a type of mutual fund , typically sold on retail investment platforms in the usual way. They invest in a spread of short-term, high-quality financial assets like cash, US government bonds, fixed-rate certificate of deposits (CDs) and high-quality corporate bonds with maturities of less than a year. Your capital is safe as a result and you can access your money at any time. Damian Hitchen, chief executive of Saxo Bank Mena, says they offer conservative investors a "compelling" alternative to cash and bonds, with the popular Fidelity Government Money Market Fund yielding 4.95 per cent. Rates have even been rising lately amid growing competition. Dubai-based high-yield money market fund Sarwa Save+ raised its rate from 3 per cent to 5.1 per cent in June, with zero transfer costs for local accounts and no minimum investment. Some individual government bonds can offer superior yields but money market funds may have an edge in other ways, according to Mr Hitchen. “They involve less capital risk as they focus on short-term, high-quality instruments that are less volatile than the longer-term securities held by bond funds. This also results in more stable and predictable yields,” he says. Amol Shitole, head of fixed income at Mashreq Capital, says money market funds are a better alternative to direct government bond investment as they invest in a diversified portfolio of short-term securities. “They display relatively low reinvestment risk as they regularly reinvest proceeds from the maturing underlying bonds into new short-term securities at market rates,” he says. They further reduce risk by targeting short-duration bonds with high credit quality, says Tony Hallside, chief executive at STP Partners. “This makes them suitable for those looking to minimise volatility and preserve capital, while earning a modest return on their money.” Many investors park cash in money market funds while waiting for the right opportunity to invest in riskier assets such as shares. This is particularly attractive for those whose investment platform only pays a low rate of interest on cash holdings, or nothing at all. “They are ideal for investors needing liquidity and stability without committing to longer-term investments or taking on the higher risks associated with the stock markets,” Mr Hallside says. After last year’s staggering success, many expected money market funds to fade in 2024 as central bankers started cutting interest rates. This would slash yields and force investors back into riskier, higher-yielding assets such as dividend-paying shares and real estate investment trusts (Reits). Yet so far, it hasn't happened. Mohamed Hashad, chief market strategist at Noor Capital, says despite the European Central Bank and Bank of Canada cutting interest rates by 25 basis points, the US Federal Reserve has so far refused to follow. It has held rates at a range of 5.25 per cent to 5.5 per cent, and we may see just one cut before the end of this year. Mr Hashad says this bodes well for money market funds as yields tend to move in tandem with interest rates. “The seven-day SEC yield, which reflects rates on US money market funds, is 5.3 per cent, right in the middle of the Fed’s rate range.” As well as preserving your capital and withstanding market turmoil, they typically have low annual charges of around 0.11 per cent a year and require a modest minimum investment of $3,000, although this varies according to the fund. Mr Hashad says money market funds may suit those saving towards short-term goals, such as buying a car, saving for a property deposit or building a pot of emergency savings. Today, they even offer an inflation-beating return, although this isn't always the case. However, in one respect, money market funds are riskier than cash. Many countries protect cash savings accounts with deposit protection schemes, which means the government will pay compensation if your bank goes, up to a certain amount. Money market funds do not benefit from this. Vijay Valecha, chief investment officer at Century Financial, says as inflation and interest rates remain high, the total invested in money market funds could top $7 trillion this year. “Yields are expected to stay elevated, as the Fed is in no rush to ease monetary policy while inflation remains above its 2 per cent target. Given the outlook, money market funds are a promising place to park your money.” Mr Valecha highlights five money market funds worth considering, all of which offer “competitive yields, low expenses and substantial assets under management”. They may not be available in every territory, but investors should find local equivalents. Vanguard Cash Reserves Federal Money Market Fund currently yields 5.27 per cent and has a low total expense ratio (TER) of 0.10 per cent. Fidelity Institutional Money Market Portfolio has an even higher yield of 5.30 per cent, although the TER is slightly higher at 0.14 per cent. The Allspring Government Money Market Fund combines a high 5.32 per cent yield with a super-low TER of 0.05 per cent. Mr Valecha also likes JPMorgan US Government Money Market Fund, which yields 5.28 per cent with a TER of 0.13 per cent, and State Street Institutional US Government Money Market Fund, which yields 5.02 per cent with a TER of 0.11 per cent. Money market funds may not rule forever. When interest rates finally start to fall, their crown could slip. That's not a problem, given their liquidity. Investors could simply pocket their returns, and move on in moments.

Why money market funds are good for short-term investments

They are ideal for investors needing liquidity and stability without committing to longer-term investments or taking on stock market risks