Money market funds vs. traditional savings: A comparative analysis of stability and returns

Money market funds have emerged as a suitable investment option for individuals looking to park their surplus funds. Traditionally, savings bank accounts have been the go-to option for most Indians when it comes to parking their short-term savings. However, money market funds offer a relatively higher return potential while also providing significant liquidity.

This article analyses money market fund investment vs traditional savings in different aspects.

• Table of contents

1. Stability of money market funds vs. traditional savings=
2. Comparative analysis of stability and returns

Stability of money market funds vs. traditional savings

When comparing the stability of money market funds vs traditional savings, the latter has the upper hand. The safety of the principal amount invested in a savings account is virtually guaranteed by the bank and hence there is a negligible risk of any loss of capital.

On the other hand, money market funds carry a risk of a fall in Net Asset Value (NAV) due to interest rate fluctuations or defaults by issuers of the underlying money market instruments, among other potential effects of market volatility.

Despite this, money market funds are among the lowest-risk mutual fund categories. They invest primarily in short-term debt instruments like treasury bills, commercial paper and certificates of deposit issued by leading banks and corporations.

The short duration of these instruments (they have a maturity of up to one year) mitigates the interest rate risk considerably. The risk of default is also low because the schemes typically invest in high-rated securities and papers.

The key difference between money market fund investment vs traditional savings Is the return potential. Money market funds have shown to have higher return potential than traditional savings account.

Comparative analysis of stability and returns

To summarise, both money market funds and savings accounts aim to provide capital stability as the primary objective. However, money market funds have demonstrated stable NAV and relatively negligible volatility of returns in the long run, despite minor fluctuations in the short term. Therefore, in terms of downside mitigation, their focus on short-term sovereign and banking sector instruments, high quality CPs has made them relatively stable.

At the same time, money market funds typically outperform savings accounts when it comes to generating return potential for investors.

Of course, investors with zero risk appetite who prioritise absolute capital guarantee over return potential may still find savings accounts better suited to their requirements.

Their ease of investment through online platforms, through distributors coupled with a relatively higher return potential, make them a suitable investment avenue for conservative investors.

Conclusion

Both money market funds and savings accounts aim to provide liquidity and capital stability for short-term savings. But the former has historically outpaced the latter when it comes to return potential. While offering lower capital guarantee than savings accounts, money market funds have been relatively stable over varied market conditions. Their focus on low-duration debt papers from reputed issuers helps such schemes mitigate risks. This makes them a suitable option for investors seeking to generate higher yields without taking on significant safety risks.

For example, the Bajaj Finserv Money Market Fund can be considered by investors who seek a relatively stable return potential along with high liquidity.

FAQs

How stable are money market funds?

Money market funds are considered relatively stable among various types of mutual fund schemes. They invest in short term debt instruments with a maturity of up to one year. This keeps the interest rate risk low. Additionally, the funds invest in high-quality papers. This helps in minimising default risk of the underlying debt instruments.

Are money market funds better than savings account?

Money market funds offer the potential for higher returns than savings accounts due to their investment nature. However, savings accounts provide more stability of the principal through federal deposit insurance. The best approach depends on an individual's specific priorities around returns, liquidity needs, and risk tolerance.

How do money market funds differ from traditional savings accounts?

Money market funds invest in short-term debt instruments, while savings accounts are typically deposits in banks. Money market funds are subject to market fluctuations, though generally less volatile than other fund types. Savings accounts offer relatively stable returns, often with lower interest rates.

Are money market funds riskier than savings accounts?

Yes. Money market funds carry some degree of risk as their net asset value can fluctuate, although they are generally considered relatively low-risk. Savings accounts with deposit insurance offer principal protection up to a certain limit, making them relatively lower risk.

What factors affect the returns of money market funds?

Interest rate movements are the primary driver of money market fund returns. Changes in the repo rate, and overall liquidity in the market will affect their performance. The fund manager's expertise in selecting instruments also plays a role.

Who should consider investing in money market funds over savings accounts?

Investors seeking slightly higher returns than traditional savings accounts and who have a moderate risk tolerance may find money market funds suitable. Those prioritizing principal protection and very low risk may prefer savings accounts.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.