The first step to investing using a platform like Hatch is depositing money. But because not everyone is always ready to choose their investment immediately after depositing, the money needs to sit in a secure place that’s easily accessible to withdraw from - known as having high liquidity. And that’s called a money market fund.
A money market fund is also where money is stored after selling shares, prior to buying new shares or withdrawing the funds. Some investors may even choose to keep their non-invested money temporarily sitting in the money market fund during times of particularly volatile share markets before they make any decisions to withdraw or invest. And other investors may choose to set up their own accounts for individually investing in a money market fund rather than investing it on the share markets or in other assets, or having it sit in a bank account.
There are pros and cons to keeping your cash in money market funds; they often pay dividends, but they can have an impact on your tax obligations if you are a Kiwi investing overseas. We explain more about dividends and Foreign Investment Fund (FIF) tax rules below. But first, why store funds in a money market fund?
How do money market funds work?
Money market funds, also called money market mutual funds, are a common place to park money temporarily - as short as just one day - before it’s invested elsewhere or withdrawn as cash. Because they offer a ‘high degree of safety’, are readily accessible to withdraw from and some may provide higher returns than traditional savings accounts, money market funds may be the preferred option for risk-averse people looking to store their money in the short term.
With Hatch, having your money stored in a money market fund means it isn’t locked away and difficult to access; it’s available to you whenever you want to invest or withdraw it.
Money market funds are types of mutual funds that spread money across lower-risk investments, such as cash, or cash equivalent securities, certificates of deposit, or US Treasury securities. Managed by fund managers and backed by investment fund companies, a money market fund’s goal is keeping the value of the money stable. This means that while returns can fluctuate, ideally in the short term, US$1 invested will always be worth around US$1 - referred to as net asset value (NAV).
The money market fund Hatch uses is specific to the United States; but they are available in various countries around the world and function in much the same way. The names and regulations vary between countries, so today we’ll cover the definition of a money market fund specific to people investing in the US markets.
What are the different types of money market funds?
There are many money market funds that are considered ‘safe investments’ to park money at low cost. When you invest with Hatch, your money is stored in a Dreyfus BNY Mellon money market fund, which has a fund rating from three globally reputable ratings agencies - S&P, Moody’s and NAIC. Other high profile investment companies that sponsor money market funds include Fidelity, Invesco, JPMorgan, BlackRock and Vanguard.
In the US, money market funds typically fall into four categories:
- US Treasury funds include a mix of low risk US government securities and are exempt from tax but offer lower returns.
- US government and agency funds comprise a mix of federal government agencies bonds and notes that have the benefit of being backed by US Treasury and Congress. Some also invest in foreign markets, emerging markets, and mortgage-related securities making them slightly riskier but with the potential to offer slightly higher returns.
- Diversified taxable funds invest in US corporations and foreign companies’ commercial paper, like repurchase agreements or payroll short-term debt. Others invest in foreign bank-issued deposits. These funds come with slightly more risk but potentially higher returns.
- Tax-free funds are the most complicated and risky of the money market funds. They’re exempt from paying US federal tax and suit US investors who either live in high tax-paying US states or sit in a higher tax bracket.
What are the benefits of a money market fund?
Along with being considered generally conservative ‘safe investments’, money market funds can pay dividends. So yep, with Hatch, your uninvested money could even receive dividends! That means, while your money is parked in a money market fund, it's always working for you.
Most money market funds pay monthly or quarterly dividends that typically mimic the current US interest rates. So if interest rates are around 4%, investors will typically receive around 4% of any money sitting in the fund as a dividend.
What are the risks of a money market fund?
Typically money market funds are considered lower-risk funds. But that doesn’t mean they are completely immune from risk altogether - no investment is!
There are three possible risks that a money market fund may be exposed to. These are:
- Interest rate risk - could happen when interest rate hikes decrease the value of a fund’s investments. For example, if interest rates are at 5% and a money market fund returns a dividend rate of 3-4%, an investor may be losing out on potential returns.
- Liquidity risk - may occur during extreme market volatility when more money is being withdrawn than there is available in the fund.
- Credit risk - would only occur in very atypical circumstances when the credit rating is downgraded or there is a high risk of default. This is an unlikely scenario as money market funds are required to have minimal credit risk and are expected to be highly rated.
Discover more about risk in our free Getting Started Course
What are NZ tax rules for money market funds?
Money market funds are often used by investing platforms or financial institutions to store any uninvested money over the short term. This is because it’s the simplest option for most investors. But it does affect some investors when it comes to tax time. This is because under New Zealand’s Foreign Investment Fund (FIF) tax rules, the available balance showing in a customer account is treated as an investment, which affects investors who have $50,000 NZD or more invested overseas during a tax year.
Kiwis are required to pay tax on US dividends (Hatch investors, we sort this for you!). But in addition, any money invested in a money market fund on your behalf by an investment platform - either before or after investing in the share markets - is included in the total investment cost amount each year and counts towards the $50,000 NZD FIF tax threshold.
If a Kiwi had $49,000 NZD invested in an overseas share market and then deposited $2,000 NZD into an investment platform account - such as Hatch - that $2K NZD, which is automatically invested in the money market fund, is added to the total investment cost adding up to $51,000 NZD. Therefore New Zealand’s FIF tax rules would apply.
Visit our Tax Centre to understand how FIF rules affect you
Money market funds are a low risk, hassle-free way to store money while still getting returns, making them one less thing to think about while you’re on your investment journey.