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Canadian Money-Market Funds

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RANGA CHAND
From Ranga Chand's Getting Started with Mutual Funds

Money-market funds invest in short-term debt securities such as commercial paper, certificates of deposit, bankers' acceptances, and federal and provincial treasury bills (T-bills), all generically known as money-market instruments. This means the money you invest in a money-market fund is used for short-term loans to various Canadian companies and government bodies.

A money-market fund is the ideal place for money that will be needed in the near future, to keep an emergency cash fund, or to park your money while seeking more attractive investment opportunities. If interest rates are high, and the stock or bond market is looking unsettled, you may want to let the money sit until things calm down. These funds generally pay two or three percentage points higher rates of return than savings accounts and are extremely safe because of the short-term nature of the investments held. If safety of capital is your number one concern, you should choose a money-market fund that invests exclusively in treasury bills. This is as risk-free as you can get, because the Government of Canada stands behind the T-bills in the fund's portfolio. As money-market funds move away from Government of Canada treasury bills to provincial treasury bills and debentures issued by major corporations, the risk increases -- but it is still extremely small.

The main difference between the assets held in money-market funds and bond funds is the term to maturity (the date on which the loan falls due). Some money-market securities mature in as little as twenty-four hours; others mature in ninety days or several months. The maximum maturity is 364 days. Keep in mind that the longer the maturity, the less quickly the fund manager will be able to exchange investments for ones with higher interest rates, should rates rise. If you think interest rates are headed up, you may want to put your money into a fund with shorter-term maturities. When the fund manager invests at the higher rates, the higher yields are passed on to you. Because money-market funds tend to turn over their portfolios very quickly, annual reports may not accurately reflect a fund's holdings. Call and ask for the maturity dates of its current holdings if you are in any doubt.

Unlike other mutual funds' unit prices, which reflect the market in which those funds invest, the unit prices of money-market funds do not fluctuate but are regulated to remain fixed at $10. This way, only the fund's yield fluctuates. When you are shopping for a money-market fund, you will notice that the advertisements usually give two rates of return -- an indicated yield and an effective yield. The indicated yield is usually the amount actually earned by the fund during the latest seven-day period, annualized. The effective yield assumes that the fund will continue to yield this amount every week on an annual basis. That is, it assumes that the rate of interest will remain unchanged over the period of one year. This could be a rather large assumption. If, for example, interest rates decline, the effective yield could be considerably less.

One of the attractive features of this type of fund is that in most cases you can get your money out by the next business day. Some funds also offer chequing privileges with balances in excess of $5,000. Be sure to check the prospectus if you want cheque-writing privileges, because there can be restrictions on the minimum amunt to be withdrawn and also on the number of cheques you can write.

Money-Market Fund Returns

Since the performance of money-market funds tends to cluster in a fairly narrow band (generally about 1.5% between the best and worst return), it makes little sense to buy units in funds that charge sales commissions. Clearly, the consistent performers that have the lowest management expense ratios and do not charge sales fees will have the edge. Load companies that offer a "family" of funds should be willing to waive this fee if you invest, or are already invested, in other family members. (Most mutual fund companies offer a family of funds which includes money-market, fixed income, and equity funds.)

Interest income from most money-market funds is paid by monthly cheque, deposited directly into your bank account, or is automatically reinvested in additional fund units. All Canadian money-market funds currently available are RRSP eligible.

A Final Word

About the only downside to investing in a money-market fund is that when interest rates are low, the interest the fund pays will also be low, and you could be earning more money elsewhere.

Key Points to Remember

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