Add money market funds to your mutual fund portfolio for diversification

There are mutual funds that are of very high risk and then there are schemes which may not have a high risk returns tradeoff, but they hold the potential to offer far better returns that conservative schemes. Most Indian investors are comfortable investing their hard earned money in schemes offering fixed interest rates. However, the interest rates have been drastically falling in the recent past, and this has resulted in several investors switching to mutual funds like debt schemes. It is almost impossible to target your life’s long term financial goals which investing in schemes that offer 4 percent – 7 percent interest rates. Debt funds may not offer fixed returns, but they are considered to a viable option for anyone with moderate to low risk appetite.

What is debt mutual funds?

While equity mutual funds predominantly invest in equity and equity related instruments for income generation, a debt mutual fund scheme is known to invest in fixed income securities and money market instruments that generate regular income. Depending on the debt fund’s nature, its risk profile, investment objective and asset allocation strategy, the fund manager may invest across securities like G-sec, corporate bonds, debentures, treasury bills, commercial papers, certificate of deposits, company fixed deposits etc. Although debt funds may or may not be able to offer returns like equity schemes, they do hold the potential to generate steady capital appreciation.

What are money market funds?

As of now there are 15 subcategories under debt funds. Out of them, money market funds are those debt schemes that offer high liquidity. Investors with low risk appetite and a short term investment horizon generally consider investing in money market funds. These debt schemes invest in money market instruments like cash and cash equivalent, high rated bonds. The securities which the money market fund manager picks usually have a maturity period of one year and below. Apart from the fact that this fund aims to generate stable income with minimum investment risk, money market funds also try to ensure that the NAV of the scheme doesn’t fluctuate much.

Things to consider before adding money market funds to your portfolio

Direct or regular plan? Which one will you choose? – Investors can either invest in money market funds via a direct plan or a regular plan. A direct plan is the one which is available with the fund house or AMC owning that particular fund. These expense ratio of a direct plan is generally low because there is no third party involved in selling this plan. A regular plan is generally available with mutual fund agents, brokers, and other aggregators for purchase. Investors can buy a regular plan without having to visit the AMC. However, the expense ratio of regular plans is high because the AMC has to pay commission fees to these third party aggregators.

Growth or dividend? Choose one – A growth option is where the interest earned by the scheme is usually reinvested back in the fund. Over time, this may result in the per unit value of the fund’s NAV. Investors with a long term investment horizon generally opt for the growth plan. A dividend plan on the other hand is for those who seek regular income from their mutual fund scheme investments. Since dividends are distributed from the fund’s NAV, the per unit value of its NAV may decline in future.

SIP or lumpsum? – A lumpsum investment is considered by those who have surplus cash sitting idle. A Systematic Investment Plan (SIP) on the other hand ensures that you invest a fixed amount at regular intervals in a money market fund of your choice. SIP is ideal to inculcate the discipline of regular investing.