Smart Ideas for Money Management

January 24, 2011

You get your salary at month end, what do you do next? Chances are that you let it lie in your bank account and withdraw as and when you need it throughout the month. It may be hard to believe but for many of us, there is still some money left in the bank account at the time when our next pay cheque arrives. The money resting in the bank earns no or negligible return.

Welcome Money Market Funds

With little or no extra effort and just a little discipline, you can quite easily earn a decent return on your cash. This can be achieved through investments in what are known as Money Market Funds (or schemes).

An investor should always ask three basic questions whenever an investment proposal is presented to him or her; ‘What about the security of my capital?’, ‘What about the return?’ and finally, ‘How can I get my money back should I need it?’ We present the answers to these questions for Money Market Funds through a comparison with your typical bank account.

What about the security of my capital?

A Money Market Fund invests a minimum of 70% of its assets in securities issued by the Government of Pakistan. In terms of credit rating, these securities can be categorized as AAA. The balance is generally deposited with high quality banks with a credit rating of AA or better. On the other hand, in most cases, the bank that you maintain an account with would have a credit rating of AA or lower. Therefore, the security of your capital through a Money Market Fund is better than that available with your bank.

What about the return?

When your cash is lying in a current account of a bank, you do not earn any return on it. If instead, the cash is deposited in a savings account, you are likely to earn a return of around 5-8% per annum. In the current interest rate environment in the country, Money Market Funds are yielding a return between 11-12% per annum.

The return on Money Market Funds is mostly tax-free (subject to conditions), while individuals are taxed at a rate of 10% on the return earned on a savings account. Additionally, an investor is able to reclaim up to Rs. 75,000 through tax credit by investing in these funds. This makes the overall return on Money Market Funds considerably higher than that available by putting your money in a bank account.

How can I get my money back should I need it?

Accessing your money through a Money Market Fund is easy. You do not invest for a fixed time period and the fund management company is able to return your money along with the accrued profit within three days of your request. Some funds even offer a same day redemption facility to investors i.e. if you file a request to get your money back in the morning, your account will be credited the same day. On the other hand, a minimum deposit period may be required to avail the rates offered by banks.

How to make the best use of Money Market Funds?

Now that we have determined why Money Market Funds are a fruitful and safe medium to invest, we discuss two approaches that investors could employ to make the best use of their idle cash.

For a regular saver

Suppose you earn Rs. 100,000 every month and through your experience you know that on average you spend around Rs. 90,000 each month. At the time you receive your salary, you can set aside Rs. 10,000 to be invested in a Money Market Fund. Such an approach would result in disciplined saving and also generate a return on your cash that was effectively lying idle previously. Following this strategy, an investor would end up saving Rs. 120,000 in a year and those savings would have accumulated a profit of around Rs. 7,150, assuming an overall return of 11% during the year. Based on your income tax bracket, you could also receive a tax credit of Rs.12,000 for the year.

Of course, if you find yourself spending more than Rs. 90,000 and need cash, you can easily withdraw from your investments.

For a non-saver

If you find yourself spending the entire Rs. 100,000 that you earn in the month, you could still generate a decent return on this amount. It is unlikely that you would be spending the entire salary in the first week of the month. So an alternative would be to set aside say Rs. 50,000 in a Money Market Fund as soon as you receive your salary with the intention of withdrawing your investments in the middle of the month when you would need the cash.

If such a strategy is followed, whereby the individual is invested in a Money Market Fund for just 15 days every month, he would be invested for a total of 180 days over the course of the year.This would result in him/her making around Rs. 2,500 over the year by just managing his/her money smartly.