The financial instrument which has short term maturity up to one year is known as the money market instrument. These tools are utilized for raising capital that offers a fixed interest rate that is generally unsecured.
There are several money market instruments like commercial papers, treasury bills, and certificates of deposits, repurchase agreements, and banker’s agreements.
The features of money market instruments are as follows:
- It has high liquidity.
- It offers the most secure investment.
- There is a fixed return.
Let us look at the basic concepts of the Money Market Fund and Savings Account, to understand the differences between the two:
What is a money market fund?
Investors are always on the lookout for safe investment options with a lower risk tolerance that offers fixed returns and maintains liquidity. A money market fund is preferred as a short-term debt investing option. These are debt funds that offer good returns over one year and also maintain high levels of quality.
How do they work?
You invest in a money market fund with the purpose of good returns and also maintaining the NAV fluctuation by keeping it minimal. NAV stands for the Net Asset Value that represents a particular mutual fund’s market value per share.
The best money market funds in India as per their performance in the previous five years are as follows:
- Aditya Birla Sun Life Money Manager Fund.
- HDFC Money Market Fund, L & T Money Market Fund.
- Franklin India Savings Fund.
- Nippon India Money Market Fund.
Who must invest in Money Market Fund?
Investors who have a good cash amount in their savings account have a higher chance of getting better returns if they invest in these funds. There are multiple investment schemes for investors who have less risk tolerance and investment horizon up to one year. These types of funds are short-term surplus cash that is often recommended to investors who won’t need the cash urgently.
Factors to keep in mind before one invests in the money market funds
- They are debt funds that carry risks such as credit risk and interest rate risk.
- The expense ratio is used to determine the earnings you get from the money market fund. So, if you are looking for bigger returns then you will have to look for a low expense ratio.
- Investing as per your investment plan is another essential factor. The money market funds have an investment period between 90-365 days.
- In money market funds, the rules for taxation are as follows:
- If you hold the scheme for 3 years, in that case, the capital gains you make are known as short-term capital gains. It is considered as your taxable income that is applicable as per the income tax slab.
- If you keep the scheme for not less than 3 years then capital gains you earn are known as long-term capital gains. The tax charged is 20% along with indexation benefits.
What is a savings account?
A savings account is an account where you deposit your cash to keep it safe and withdraw funds, along with earning interests. Most banks offering savings accounts are FDIC insured and pay interest as per your deposit.
How does it work?
It is wise to have a savings account where you can deposit your money to avoid excess spending. We often tend to spend the money in hand therefore a savings account is the best option to keep the money aside. These funds can be used to reach longer-term goals. They also offer easy access to your account and you can withdraw your money as you require. You can also use electronic funds transfer to transfer your money. And can also make withdrawals with the help of an ATM.
Even though they are typically free, there are certain limitations and an additional fee charged. You need to have a minimum balance in your savings account. The bank will charge a monthly fee or annual fee if you do not have a minimum balance. There is also a possibility of overdraft fees if your account balance becomes below zero. People use savings accounts for multiple purposes like savings for major occasions or purchases, for a vacation or emergency.
Which one should you choose?
Money market funds and savings accounts seem quite similar but are different. While a savings account offers complete safety, it is ideal for keeping your money safe so that you don’t lose it. On the other hand, Money market funds offer little increase in returns but make access to your cash difficult. It also introduces some risk factors. But remember that you can use both these types of accounts for different purposes. The three basic things to consider are given below:
- An emergency fund is your priority- If you will need the cash in near future, then you should consider opening a savings account. A savings account must be used for holding your emergency funds because it is easily accessible. Once you have kept away your emergency fund in your savings account including your living expenses for roughly 3 to 6 months. You can opt for taking a slight risk and open a money market fund. If you do not need to access your money for a long time, you can earn a bit more interest along with maintaining your savings account.
- Exceeding FDIC limits- If you have a lot of money to invest apart from your savings account then you can consider opening a money market fund.