Money Market Funds Vs Savings Accounts

A lot of people learn at an early age, the importance of saving. From a young age, many are encouraged to save through tools like piggy banks and gradually migrate into a bank. Over time, banks have adapted and created diverse financial products for all ages and backgrounds. Despite this, fixed deposit interest rates at many institutions have decreased in pursuit of profitability. This has opened the door for money market funds, which offer potentially higher returns compared to traditional savings options.

Money Market Funds are a good alternative that have emerged over the years. A money market fund is a product that offers exposure to a fine blend of short-term financing instruments, carefully selected by professional fund managers with the investment goals of the targeted clients in mind. Money Market funds, as an alternative, have gained prominence over the years as they seek to proffer better returns to their targeted clients when compared to the returns on savings account in a bank. To achieve these returns, fund managers proceed to actively manage the pool of funds to effectively attain the expected returns as against the passive management strategy employed by banks to generate returns for their prospective investors. For example, fund managers may actively adjust the fund's portfolio by selecting short-term instruments with favorable yields based on their analysis of market conditions, interest rates, and credit quality unlike in passive management where there is minimal active decision-making involved.

Interestingly, over time, it has been proven that the most effective principle to create wealth is through the principle of “compounding interest”. Compound Interest in simple terms is the prospective returns that can be earned on returns already earned. Imagine, an investor taking up a fixed deposit for 1 year at an agreed-upon interest rate of 5% per annum. At the end of the year, the Fixed Deposit investor earns ₦50,000 in interest (₦1,000,000 * 5%). Now, imagine another investor that invests in money market fund. The investor Invests ₦1,000,000 in a money market mutual fund with a quarterly interest distribution. Let's assume the fund pays a quarterly interest rate of 1.25%, leading to an annual rate of 5% (1.25% * 4 quarters). After the first quarter, the investor earns ₦12,500 in interest (₦1,000,000 * 1.25%). For the second quarter, the interest is calculated on the new total (₦1,012,500 * 1.25%), resulting in ₦12,656.25. This process continues for the remaining two quarters. At the end of the year, the total interest earned is more than ₦50,000 due to earning interest on the interest in each quarter. The Money Market Fund Investor, due to the compounding effect, would earn a slightly higher amount. Let's assume the total interest earned is ₦52,660. The example shows us the potential advantage of compounding returns in money market funds, especially when compared to fixed deposits, particularly in an environment with increasing inflationary pressures. Little wonder that money market funds have replaced the traditional savings account for some investors.

Another safe way to create wealth is through “diversification”. Diversification simply means not putting all your eggs in one basket.  In estimating the real value of funds, funds allocated to significant risks are valued lower because the funds have a higher probability of getting lost in an event where the risk event occurs. So, in delivering higher returns and also meeting liquidity needs that may arise, fund managers cultivate the habit of diversification by allocating funds to various viable and verifiable short-tenured money market instruments in line with the risk profile of prospective investors. These assets mainly include treasury bills, commercial papers, and fixed deposits.

Investors might choose a Money Market Fund over a Savings Account if the goal for the investor is for a relatively safe option with the potential for higher returns than a standard savings account, a Money Market Fund might be a suitable choice. In addition, a money market fund will be a good choice if an investor has a short investment horizon (e.g., a few months to a couple of years) and wants to preserve capital while earning a bit more interest than a savings account. In concluding, if an investor desires regular income or prefers a more frequent interest payout, a Money Market Fund could be better with their needs. Also, it will be good for investors to bear in mind that Money Market Funds typically charge management fees to cover the costs of managing the fund. These fees are expressed as an annual percentage of the fund's assets under management (AUM). The range usually varies, but it's generally lower than fees associated with more actively managed funds.

The author, IfeOluwa Oladapo-Dixon, is an Assistant Director at FBNQuest Asset Management and the lead fund manager of the FBN Money Market Fund, the FBN Bond Fund, amongst other investment portfolios she manages in the firm.

This article is not financial advice and individuals/institutions should consult a financial professional for their specific needs.