Investing in the money market may offer you better returns than those you can earn from a savings account - and your money is almost as safe as it is in the bank. This type of investment is ideal for money you want to put away over the short term, such as savings for a deposit on a property. It also offers quick access to your money.
You may also need to put some of your savings in a money market account to diversify your investment portfolio.
The money market is less suitable for long-term investments because it may not always keep up with inflation. For short-term investments, it can be less volatile than, for example, equities.
The wholesale money market is where banks and other financial institutions lend and borrow large sums of money. The rates paid are generally better than what your relatively small amount can earn in a savings account.
Two types of securities are traded on the wholesale money market: interest rate instruments and discount instruments.
- Interest rate instruments, such as short-term debentures and short-term gilts, offer you interest on the amount you invest.
- Discount instruments, such as treasury bills and promissory notes, do not pay interest, but they are issued at a discount to the guaranteed amount on maturity. Instead of receiving interest, you get a discount on what you pay for them.
These short-term financial instruments have a maturity period of a year or less. Individual investors don't have direct access to interest rate and discount instruments because of the large sums of money involved. However, you can invest in the money market indirectly through specialised unit trust funds or bank accounts (See "Money market bank accounts" and "Money market unit trusts").
When you invest in a money market unit trust fund or bank account, your money is pooled with that of other investors. The pooled amount is used to buy money market instruments, and in this way you can enjoy the higher interest rates they offer.
Although money market investments offer better rates than most bank savings accounts, the interest you will earn over the long term is not as high as the returns you can get from asset classes such as equities, bonds and property.
Because money market investments are low risk but offer lower returns, they are more suited for short-term savings goals.
To contain risk, corporate financial products such as endowment policies and retirement annuities have a portion of their assets invested in the money market.
What goes to tax
You pay tax on any interest you earn on a cash investment such as a money market unit trust or money market bank account. However, you enjoy a tax exemption on interest earned each tax year up to a certain amount.
The tax-free interest income ceiling for the 2009/10 tax year is R21 000 if you are under 65 and R30 000 if you are 65 or older.
Your unit trust fund or bank will send you a tax certificate that shows the interest you earned, and you will have to declare this amount on your tax return.
Money market bank accounts
When you invest in a money market bank account, the bank becomes the custodian of your money and your money is used to finance that bank. This means that, as with other types of bank account, you are exposed fully to that particular bank.
So if the bank collapses, you stand to lose all or some of your money, depending on the extent to which the bank's liabilities exceed its assets.
The minimum investment amounts for these accounts can be high at R10 000. The more you invest, the higher the interest you will earn.
Interest is calculated daily and capitalised to your account once a month.
There are usually no investment charges on money market bank accounts.
Some such accounts offer limited transactions, such as withdrawals, inter-account transfers and even stop and debit order facilities. However, the transaction fees are high to encourage you to stay invested.
Although your returns on money market investments are not guaranteed, some banks have products that offer returns similar to those offered by money market accounts or funds, but that also come with a guarantee that your returns will not be less than a certain percentage below the prime rate.
Unlike a fixed deposit, your money is not locked into a specific investment term, and you don't have to give the bank notice if you want to withdraw part or all of your funds.
Money market unit trusts
The main difference between money market bank accounts and money market unit trusts is the diversification of risk. In the former your money is invested in the instruments of a single bank, whereas a money market unit trust fund may not have more than 30 percent of its assets invested in one bank.
This means in a fund that invests in the instruments of, say, four different banks, the risk of losing money as a result of a bank going under is diversified across four banks.
Money market fund managers place your investment with institutions that want to borrow money for short periods, usually less than a year. The average duration, or term to maturity, of the financial instruments held by a money market unit trust fund cannot be longer than 90 days.
When interest rates are falling, the fund can lock into a higher interest rate for 90 days or longer on some instruments, as long as the average duration of all the instruments does not exceed the 90-day limit.
Legislative advantage
An advantage of investing in the money market through a unit trust is that your investment falls under the Collective Investment Schemes Control Act.
The assets in the money market fund must be held in a separate trust and not as part of the assets of the unit trust management company. This means that if the management company collapses, your money is protected.
Minimum amounts
The minimum lump sum investment for money market unit trust funds is usually between R10 000 and R50 000, although some funds accept as little as R1 000.
For recurring investments, you will need to invest about R1 000 a month, although some funds accept as little as R200.
Usually, there are no transaction facilities on money market unit trust accounts.
You may have to pay an initial fee of 0.4 or 0.5 percent of your investment (although most funds no longer charge an initial fee), and there is usually an annual fee of about 0.5 percent a year.
If you disinvest, you can access your money within 48 hours.
Yields
The interest you earn on a money market unit trust is calculated daily and distributed to you monthly in arrears.
Each money market fund calculates its return by way of a yield. In its simplest form, all income earned by the fund for a day, less expenses, is divided by the value of the fund and then multiplied first by 100 and then by 365 to give you a percentage. This is the annualised yield that you would earn on that day. The daily income and expenses vary, so the yield is compounded and averaged out over seven days.
This figure is published in the financial media and is what you would use to compare different funds. At face value, the fund with the highest yield offers the best return for the day. But different managers invest in different instruments. A higher yield may indicate that the fund has a different average term or that it includes instruments that carry higher risk, increasing the potential for the income earned to rise and fall.
No guarantees
Unlike other types of unit trusts, a money market fund normally has a stable capital price of R1 a unit.
But neither your capital nor your returns on money market investments are guaranteed as they would be if you invested in, for example, a fixed deposit. Your returns will vary in line with interest rates, and your capital is likely to remain stable, but there is some chance that it could decrease.
Mike Ronald, a fund manager at Marriott, says that to increase their yields and remain attractive to investors, money market funds often invest in a variety of financial instruments, including bonds of a suitable duration.
However, he points out that such instruments come with capital risk and values, which can vary daily. Any variance in the value of the underlying capital gets added to or subtracted from the day's net income in arriving at the day's rate. So a bond originally bought at a small discount could result in you earning more than just the interest earned by the fund.
But Ronald says the opposite also holds true and any downward move in asset values would reduce your returns.
Capital loss
Other types of investment a money market fund can hold are bank deposits backed by a defined set of assets, often called asset-backed deposits. With such deposits, your capital is not guaranteed and it can decrease under certain conditions. Interest earned on these deposits is not predefined but is calculated with reference to the returns on a predetermined set of investment instruments, Ronald says.
Hence, the income earned and, under certain circumstances, the capital value of these deposits can fluctuate, sometimes with significant results. If the investment is big enough, it could lead to a portion or even all of the money market fund's income being eroded and may even lead to a decline in the R1 unit price of the fund.
For example, in September 2008, a certain money market fund in the United States had to decrease its price below one dollar because of its exposure to investment bank Lehman Brothers, which had collapsed. This resulted in large outflows from the fund, and American regulators had to offer temporary insurance to money market investors to restore confidence in the product.