Recent legal drama involving Britam Limited employees and Cytonn Investments is an eye opener in the money markets. Who ever thought a seemingly safe investment vehicle could cause a loss of one billion Kenya Shillings? It is a reminder to investors that no investment is really safe or risk-free!
Come with us as we take you through the spooky investment stories that underscore the risk of the money markets.
1. The Case of Misleading High Yields
Some investments are outrightly too good to be true! Suppose you invest in what is seemingly a safe money market fund that promises a higher return than the market benchmark? Should you not be worried? More often, it is ignored until things go south and the fund starts eating into your principal. The Reserve Fund is a classic example where in 2008 it was unable to maintain its net asset value at $1 per share, hence eating into investors’ principle despite promising high returns!
So, how do you hedge yourself against misleading yields?
- Be vigilant on Too-Good-to-Be True yields! Every investment has a risk. It’s important to objectively read and understand how the company generates returns.
- Reputation of the fund manager is vital. Reputable managers have a good track record and are less likely to engage in unethical practices.
2. Money Markets “Guaranteed Returns”?
Be wary of marketing baits such as “guaranteed returns.” Such investments do not normally exist. Stanford Financial Group in 2008 duped investors into purchasing their certificates of deposit, which then were hyped as investments with guaranteed returns!
The fraud cases that later accompanied the company led to the loss of money by over 25000 investors who have been investing on their certificates for deposits for over 15 years.
Be on the lookout for the red flags such as:
- Guarantees as the selling point! No investment will come without risk. Ensure that you have clear terms and conditions for any investment guarantee.
- While we may all not be conversant with the prevailing market conditions, at least try to understand the basics. Some investments rely heavily on unpredictable market conditions! This should be your reason to quit.
3. Inflation might be depleting Your Money Market Returns!
Inflation is one of the silent killers in the money market funds. In 2016, many financial institutions faced challenges in meeting the obligations on promised yields due to inflation. Situations where
Inflation rates are rising while the return remains constant eat into investors’ principle. Furthermore, it increases the seasons for companies to recoup their initial expenditure, which may eventually lead to losses!
To be safe, investors need to understand what real returns are!
- When calculating investment returns, factor in inflation. If you fail to factor in inflation, you will be earning while in real terms you are making losses. Ensure that your returns are higher than the underlying inflation rate.
- Portfolio diversification is a key! Putting all your investments in a single asset class can brew risks. Do a mix of assets to help you offset inflation risk and losses.
4. The Creeping Management Fees and Taxes
There is also a common ghost in money markets that many investors overlook. Management fees and taxes on money MMFs are compulsory. Importantly, fee determinations are under the discretion of the fund manager. Sadly, fund managers may increase fees without prior notice. Every return you make is also subject to 15% withholding tax.
Failure to remember this when investing in Money Market funds will give you a fall expectation of a higher return! You may be surprised to realize that what you are really getting is too small due to exorbitant management fees, which will drain your account.
What to look out for:
- So first, make sure you clearly understand the fee structure. Here, you will be focusing on the management fee ratio to your return on the money market fund.
- Evaluate the impact of fees on your returns! High fees can eat all your returns, including the principle, especially if you choose a low-yield environment.
5. The Rogue Fund Manager: Ponzi Schemes Disguised as Funds
Fund managers are important considerations when choosing a money market to invest in. A classic case on point is the collapse of Deacons East Africa in 2016! The management was accused of misappropriating funds from the MMF in an attempt to cover business losses. The fund, which was supposed to offer stable returns, ended up using new investors’ money to pay off earlier investors. The collapse of this scheme led to serious money losses. Investors lost their savings through the rogue fund managers!
You can surely save yourself from these issues only if you do your assignment!
- First, be sure that the company has no regulatory oversight! You can check with regulatory authorities to be sure that they are legitimate financial authorities.
- You cannot solely rely on the flashy marketing people who are only keen on making a sale! Check what the third-party customer reviews are saying, because reviews never lie.
6. The Liquidity Lockdown in Money Markets: Redemption Restrictions
Before you subscribe to a money market, be sure that you have read the terms and conditions on redemptions. Many investors are facing liquidity lockdown, a situation where you want to urgently redeem your funds but the fund says that they are facing market conditions challenges! That should not be your business. A good fund should accord you rights to redeem whenever you deem fit to redeem.
What to look out for:
- To be safe, read and understand the liquidity provisions in their terms and conditions manuals. If your money market has caveats on seasons of market stress, then it will be wise to avoid it all together.
- Keep some of your money in highly liquid accounts in anticipation of unexpected occurrences.
Also Read: Unlocking Wealth With Dividend Stocks
Final Thoughts: Don’t Let Your Investments Haunt You
Your investment should be your friend when you are in need! It should not be part of the reasons you are seeing that therapist. Not all money markets are safe bets; be sure to do proper research with meticulous attention to all details, lest your investment switch to a horror story! With the right information, you will never go wrong with the money Market funds!
