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The amount that is invested is unusable for some time. It is therefore plain common sense to make sure that this will not be needed for anything urgent. That’s why financial advisers caution aspiring investors to begin by building an emergency fund first before investing.
Investopedia defines emergency funds as follows:
An account that is used to set aside funds to be used in an emergency, such as the loss of a job, an illness or a major expense. The purpose of the fund is to improve financial security by creating a safety net of funds that can be used to meet emergency expenses as well as reduce the need to use high interest debt, such as credit cards, as a last resort.To serve its purpose, emergency funds should be liquid. That’s why most emergency funds are in deposit accounts.
The only problem with deposit accounts is their low interest rates. So your emergency fund that sits idle in the bank will earn less than one percent a year. That is the price you pay for safety and liquidity.
Better Alternative to Bank DepositsBut is there a way to earn more than deposit interest rates while maintaining the same level of safety and liquidity?
Actually, there is. This can be done by investing in money market funds. Surely there are pros and cons compared to bank deposit. But money market funds are the closest we can get to deposit accounts’ liquidity with relatively better yield.
Money market funds are investment funds that have portfolios comprised of short-term (less than one year) debt securities. These short-term securities may include the following:
- Treasury Bills - government securities which mature in less than a year. There are three tenors of Treasury Bills: (1) 91 day (2) 182-day (3) 364-day Bills.
- Commercial Papers - a promissory note sold by a large organization
- Certificate of Deposits - securities issued by commercial banks to raise cash for loans and other purposes.
- Low risk
- Yields relatively higher than savings and time deposit accounts
Investing in Money Market FundsI believe that money market funds are good alternatives to park your emergency funds. Instead of a savings deposit, money market funds will yield better. Although you should take care to study the particular money market fund you will invest in.
I would particularly look at sales loads, management fees and redemption fees. Given the comparatively lower yield of money market funds, fees could wipe out potential gains even before you get started. A sales load of 1% and a management fee of another 1% take away 2% potential gain. This is true for an existing money market mutual fund in the market. With a historical 1 year return of 1.82%, this mutual fund actually loses 0.18% annually after subtracting all the fees. This is worse than a savings deposit.
On the other hand, BDO Peso Money Market Fund has a 1 year return performance of 3.6% with only a 0.5% management fee. It doesn’t have any sales load or redemption fees at all.
To be sure, there are several options of money market funds to choose from. Read the fine print, check historical performance, know the fees and do your own analysis. These are the steps to go through before investing your hard-earned money. Else, you’re gambling – not good!
Due diligence should be a habit!