Money market funds offer the more conservative investor access to a low risk investment. This option offers money market returns and can serve as a safe haven for investors' capital during times of volatile market performance.
Money market funds have proven to be a popular investment safe haven as global stock market volatility has continued unabated. Over the 12 months to end April, R54,67 billion went into local money market funds - 69.4% of unit trust industry net flows.
Protection
For an investor who is looking for a short-term safehaven for their investments, a money market fund can provide protection against the volatility of markets. These funds are low risk, and generate their returns through interest income derived from investment in a variety of short-term money market instruments.
Tax exemptions
As the returns are generated through interest income, money market funds also allow individual investors to benefit from the tax exemptions available for interest income. The first R21 000 a tax year of interest income earned (R30 000 if aged 65 or older) is currently exempt from income tax.
This means that, at an interest rate of 8% pa, you could invest up to R262 500 (R375 000 if you are 65+) without incurring tax on interest income. This benefit is applied across each taxpayer's entire discretionary portfolio, excluding Life platform investments.
Low risk investments?
Investors often take comfort in the relative certainty and stability of returns that money market funds provide. It is true that they do lower risk as measured by volatility of returns, but over the medium to long term this comes at the price of lower expected returns than would be available in funds with greater exposure to growth assets such as equity.
This point is illustrated in the graph below.
Stick to the plan!
In the long run, one of the biggest determinants of the return on an investment is the relative level of the price you bought at and the price you sell at.
And also in the long run, cash has only produced a return in excess of inflation of about 0.8% p.a. It is therefore clear that for long-term investors, a knee-jerk or sustained switch into cash in the current environment is not necessarily in line with their long-term investment plan. The important thing is to consider one's individual circumstances.
*Will a switch into cash result in a capital gains tax event if the original investment was bought at a price lower than current market prices?
*Will a switch into cash result in a crystallisation of capital losses if the original investment was bought at a price higher than current market prices?
*How long will the investment remain in cash? Will it be used to fund short-term expenditure requirements in the current tough environment? And is this consistent with the investor's long-term investment plans?
Short-term safe haven
A money market fund can add great value in managing the exposure to market volatility within an investment portfolio, and as a short-term safe haven for investment capital. But, if used inappropriately, a money market investment may actually be relatively risky, if risk is defined as the chance of not meeting one's long-term investment goals.
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