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Money market unit trusts (also referred to as ‘money market funds’) are safe, secure investments. It should be understood that you won’t find an entirely risk-free investment. A good comprehension of how money market unit trusts work can assist you to use them appropriately in your portfolio.
So, what exactly is the money market? In a nutshell, the money market is where institutions such as governments, companies, and banks raise money by getting short-term loans from investors. All the transactions are conducted electronically via a network of sellers and buyers. So, the money market doesn’t exist in a physical or central location.
What is a money market instrument?
A money market instrument allows an investor to receive their principal loan, plus accumulated interest when the loan term comes to an end. Here’s an example to explain it more clearly.
- A financial institution such as a bank requires R200 million to cover operating costs for the next 12 months. They can issue money market instruments to raise this money, which numerous investors buy.
- This money market instrument offers 4.5% interest (known as the yield) with a maturity period of 12 months. Higher interest rates would likely need to be offered to compensate for investment risk if the instruments require more extended maturity periods.
- Interest accumulates until the day the instrument matures. On maturity, the investor will receive the total interest amount plus the original capital investment.
- Should the investor sell that instrument before maturity, the new holder can pick up from where the old one left off.
This may sound like a bond; the difference is the time horizon. Money market instruments usually have terms of up to 12 months.
When should I invest in a money market unit trust?
It’s worth investing in money market unit trusts for short-term savings plans such as an emergency fund. It’s a secure space to store your funds, earn returns and access it when/if required.
It could be said a money market fund is, from a practical perspective, comparable to a fixed deposit account that you get from a bank, with some advantages:
1. You can cash out whenever you want
With most fixed deposits, you can’t access the funds for a certain period of time without paying penalties. In contrast, a money market unit trust is more flexible – you can access the capital whenever required.
2. Investment diversification
A money market unit trust has investments across many financial issuers, while a fixed deposit is only with a single bank. They state your deposit will be guaranteed, but this isn’t always the case with banks, so although it’s a low-risk investment, it’s also too concentrated.
Understand the risks
So, it can be deduced that money market unit trusts are a convenient, flexible and low-risk investment when used for the correct purpose. Should you need more information, it’s a good idea to speak with an independent financial adviser who can answer any questions you may have about this type of investment.
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