The money market trap

A_6To the general public money market unit trust funds are safe and secure; a conservative, yet sensible investment that protects capital. This is a half-truth, as safety and security come at a cost. The cost? Inflation.

The money market is where the government, banks and companies raise capital through short-term loans from investors. Money market unit trust funds are similar to fixed deposit accounts offered by banks. Its main advantage over fixed deposit accounts is liquidity. Cash can be withdrawn at any time without penalties and there are no lock-in periods. This is primarily why returns offered on fixed deposits exceed money market returns.

Money market returns often fail to outperform inflation over the long term. This is the money market trap. It means that although the investment amount constantly increases, it will buy less and less over time. In this respect, money market unit trust funds can be risky and inappropriate to achieve long-term investment goals such as retirement or children’s education. The true risk is having inadequate growth assets to meet such long-term capital requirements.

Money market funds are, however, very useful as short-term safe-havens. It is ideal for short-term capital obligations and emergencies. In addition, individuals qualify for an interest income tax exemption of R23,800 per year or R34,500 for individuals older than 65 years. For example, a money market investment of R297,500 yielding 8% per annum would be tax-exempt, as the interest earned would equal R23,800.

As a rule of thumb it is not optimal to have more than one years’ living expenses and capital commitments invested in money market funds. If this is not the case, investors should consider rebalancing their portfolios.

By Frants Preis, CFA

Frants Preis is an equities portfolio manager at VEGA Asset Management

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.  Errors and omissions excepted (E&OE)

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