Commercial Paper: A Primer
February 12, 2025
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We already know that money markets are amongst the biggest sectors within the fixed-income securities market. The money market is widely used by players such as banks, mutual funds, and even individual investors because it is a great alternative to park funds in the short term.
In this article, we will have a closer look at what the pros and cons of money market funds are:
Money market funds rank high on the preference list of many investors. This is because of certain advantages that these funds have to offer. Some of these advantages have been listed below:
Most of the money in money market funds is invested in ultra-short-term securities. However, the return is almost comparable to a certificate of deposit where money has to be locked in for the long term. For most investors, money market funds allow them to earn the best possible savings rate while keeping their funds liquid.
Also, money market instruments do not face a significant drop in valuation in the event of a recession or a bear market. This is another reason why they are preferred over other financial instruments.
Money markets funds are also disliked by investors because there are some disadvantages associated with these accounts. The details of these disadvantages have been mentioned below:
It is also possible that the return may be negative even though such a situation is extremely unlikely. Hence, when investors choose money market funds, they have to forego the peace of mind which is associated with having a fixed rate of return.
Money market funds are not insured by government regulators. Hence, investors have to assume the full risks of the actions of the fund. This lack of insurance makes money market funds a lesser attractive proposition.
From an investor’s point of view, the existence of a management team means that they will have to pay a management fee. Now, the problem with money market funds is that the return earned itself is quite low. If management fees are added on top of these low returns, the investment may not seem worthwhile.
The percentage of returns has been structured to increase along with an increase in the sum of money invested. The existence of such a structure puts retail investors at a disadvantage. Hence, they often prefer to keep their investments out of the money market.
Hence, it can be said that money market funds are a very flexible tool at the hands of the investor. Unlike other short-term investments, investors can choose their own risk-return appetite. Although, they must be aware that funds that provide the best returns may not necessarily be the best investments.
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