Mutual funds and money market funds are both managed by professionals who pool investments. Mutual funds offer thousands of options with varying risks, from conservative blue-chip investments to highly speculative ones. In contrast, money market funds invest exclusively in low-risk, short-term debts like Treasury bills.
Are you looking for ways to grow your wealth? Are you confused about striking a balance between high-return financial instruments and high-risk assets? If yes, you have come to the right place. This article will help you understand mutual funds, money market funds, and the differences between mutual funds and money market funds. Learn how you can diversify your investment among these assets to strike a balance between return and risk.
Let’s start exploring the comparison between mutual funds vs money market funds by understanding these financial instruments.
What are mutual funds?
Mutual funds collect money from a large number of investors and pool it together. A qualified and professional fund manager invests on their behalf as per the policy document of the mutual fund scheme. The fund manager will invest in various securities, such as stocks, bonds, and others, depending upon the investors' risk appetites and expectation of return.
Usually, mutual fund schemes provide you with a higher return than fixed-income assets. As mutual funds invest in assets that are market-linked, market fluctuations can affect your investment. That is the reason why mutual funds have a higher risk potential than fixed-income assets.
If the market fluctuates and goes higher, your MF scheme’s value increases. This helps you make a profit. If the market falls, your mutual fund’s value drops. In such a case, you make a loss.
High-return mutual fund categories for smart investing
| Equity Mutual Funds | Hybrid Mutual Funds | Debt Mutual Funds |
| Tax Saving Mutual Funds | NFO Mutual Funds | Multi Cap Mutual Funds |
What are money market funds?
Money market funds are specialised mutual funds that invest in securities like a certificate of deposit (CD), treasury bills, commercial papers, and other similar financial instruments. These are low-risk securities that are invested for the short term.
Money market funds aim to preserve the capital you have invested and provide you with decent returns. Most commonly, money market funds are used as a cash management tool.
Money market funds are best for you if you want stability in your investment and liquidity.
Example of Money market funds vs Mutual funds
Let us understand how the two instruments work with the help of an example.
Example of mutual funds
Suppose there is a mutual fund scheme named ‘ABC Equity Growth Fund’, which has pledged to invest 80% of its funds in stocks and the rest 20% in debt instruments such as bonds. The AMC (Asset Management Company) of this scheme is now open to pooling funds from different investors.
While some investors invest through lumpsum investment by investing Rs. 10,000, Rs. 50,000, or Rs. 1 lakh, others use the SIP investment option, putting in Rs. 1,000-Rs. 5,000 as monthly instalments.
Let us assume the pooling of funds from different investors across India has swelled the accumulated fund, or AUM (Asset Under Management) of the scheme, to Rs. 60,000 crore. A qualified fund manager will then manage the AUM on behalf of all the investors. They will invest 80% of the total funds in different stocks and 20% in bonds to diversify and provide you with high returns. As most of the fund is invested in stocks, the scheme’s potential risk increases too.
This mutual fund scheme is most suitable for young professionals in their 20s and 30s (who usually have high risk-taking capacity). By investing in equity-based MFs, they can get high returns in the long run.
If you are a retiree, you can invest in funds that have invested mostly in debt instruments. A debt mutual fund usually invests 80% of the AUM in bonds and other debt-based instruments and just 20% in stocks.
Example of money market funds
Suppose ‘XYZ Money Market Fund Direct Plan-Growth’ is a money market fund. The scheme aims to provide interest income to all investors while maintaining a stable NAV (net asset value). So, the scheme invests in securities that provide you with fixed income, such as CDs, commercial papers, treasury bills, and other money market instruments.
It is important to note that money market instruments do not give you an assured or guaranteed income. As the credit rating of the issuers of CDs, commercial papers, and treasury bills is high, the return is significantly secure.
Like any other mutual fund, a money market fund pools investment money from several investors across India. Let us assume that after pooling money, the AUM of XYZ Money Market Fund Direct Plan-Growth has reached Rs. 12,000 crore.
A qualified and experienced fund manager then invests this pool of funds in short-term debt funds with less than a year of maturity. These funds provide decent interest income. If you want both the stability of the principal amount you invested and high liquidity, money market funds (also called liquid funds) are the best financial instruments available.
Differences between mutual funds and money market funds
The top 3 differences between mutual funds and money market funds are explained below:
Investment objective
- Mutual funds
Their goal is to provide you with long-term capital gains. To achieve this goal, the fund managers of mutual funds diversify. They invest in a wide array of securities including stocks, bonds, and others, to strike a balance between risk and return. - Money market funds
These funds want to preserve the capital you have invested, on the one hand, and liquidity, on the other. To provide you with both stability in income and preservation of capital, money market funds invest in short-term, low-risk securities such as CDs, commercial papers, treasury bills, etc.
Risk and return
- Mutual funds
These funds provide you with comparatively higher returns. Mutual funds are exposed to risks as they invest in market-linked assets like stocks and bonds. Market fluctuation can affect returns. They are comparatively higher-risk financial instruments and also offer you high returns. - Money market funds
These funds invest in low-risk securities, such as CDs, commercial papers, treasury bills, etc. The return of these funds is also low. But they help your scheme’s NAV to be stable all the time. They offer you income and preservation of capital and, at the same time, income stability. In comparison to mutual funds, their return and investment risk are low.
Liquidity
- Mutual funds
If you redeem all or a few units of a mutual fund scheme, it may take a few days to be credited to your bank account. - Money market funds
They are highly liquid assets. You can sell your units at the current NAV on a real-time basis.
Which is better between Money market funds or mutual funds?
The answer to this question depends upon your needs and financial goals. If you are looking for high liquidity and preservation of capital, money market funds are best for you. If your financial goal is to grow your fund over the years, equity mutual funds are your best option. If you are a retiree and prioritise the preservation of capital and regular income, a debt mutual fund can be your best option.
Conclusion
Mutual funds and money market funds are different instruments that provide varying returns. You can choose an option based on your risk tolerance and investment objective.
