If you are thinking of getting involved in money market mutual funds, you need to be aware of the dangers involved. There are some misconceptions about mutual funds that need to be addressed. The recent default of large financial institutions has caused problems for many investors, thus proving that investments are no more stable than the brokerages themselves.
Misconceptions About Mutual Funds
One misconception about money market mutual funds is that their liquidity allows for them to pay more than bank sponsored investments. This is not true, as certificates of deposits often pay a higher return on investments than mutual funds. Another misconception is that this type of investment is diversified. In actuality, many mutual funds only invest in one industry. Just because a mutual fund invests in 50 companies doesn’t mean it’s diversified, as those companies could all be part of the same sector.
Mutual Fund Misrepresentation
There is also a lot of prevalent misrepresentation in the money market. Mutual funds are often advertised in a vague manner. The law only requires funds to have 80% of the assets implied in their names. Fund management is solely in charge of the remaining 20%.
For example, when investing in a mutual fund titled “Global Precious Metal Mining Fund”, you could actually be investing in the “Brazilian Platinum Mining Fund”. There is obviously a significant difference between the two, yet you would not be aware of this unless you took the time to do research.
Sub-Optimal Purchases and Forced Redemption
By law, fund managers must always have most of the money in the stock market. Whenever you buy money market mutual funds, the manager must use your cash to buy shares of stocks that fit within the guidelines. If the choices are limited, the manager has no choice but to make sub-optimal purchases, some of which could end up being worthless. Even though money market mutual funds are supposed to involve less risky investments than other mutual funds, nothing is guaranteed.
And then there’s the problem of forced redemption. This occurs when investors sell their shares of the fund and the manager doesn’t have enough cash reserved to meet the demands. When this happens, the manager is forced into selling underlying stocks. In other words, the stocks in which you have invested are sold in order to meet the demands of the other investors. The entire fund and remaining investors suffer as a consequence.
Overvaluation of Money Market Mutual Funds
Another problem with mutual funds is that they are often overvalued. It’s difficult for investors to do research on different funds when they aren’t evaluated properly. Fund companies only rate funds on their past performance, not their current worth or future growth potential. Unlike individual stocks, the P/E ratios and sales growth can’t be compared in regards to mutual funds.
Because they are only rated due to past performance, many funds are currently overvalued. This is due to a variety of factors, including changing markets, changing economic conditions, different fund managers, and so forth. When management changes, a mutual fund is always at risk, since the new manager might not have the same amount of expertise as the previous one. These risks are not mentioned in advertisements and rankings.
Overall Risks
Despite what you might have heard, there is no guarantee on the share price of money market mutual funds. Since the rates are variable, it’s difficult to estimate the amount of principle you will earn during the following month. Due to unpredictability, these types of mutual funds are not good short-term investments. Due to inflation and little to no returns, these funds are not good long-term investments.