Short Term Money: Termed Deposit or Money Market Funds?

You look at your account balance and it's significantly more than it usually is, you just got a big payment and have no real immediate use for the cash. You immediately realize the apparent risk of spending this money unproductively, threatening your ability to meet some financial obligations in the next 3 to 12 months. Typically, you’ll keep unused cash in an interest-bearing savings account, but this time, you wonder if there are better options.

When it comes to parking your extra cash, safety and accessibility (liquidity) are often top priorities before returns. Two popular options that offer a balance between these needs are money market funds (MMFs) and fixed deposits (FDs). But which one is right for you? Understanding their key differences can help you make an informed decision.

The Security Net: Insurance and Diversification

Termed Deposits, also known as certificate of deposit (CDs) in some countries, is essentially a loan given to the bank. You deposit your money for a predetermined term, typically not more than a year (365 days). In return, the bank guarantees a fixed interest rate for the duration. This guaranteed return is a major advantage of TDs, especially in times of economic uncertainty.  The safety of your principal is further increased by deposit insurance schemes, which protect your money up to a certain limit in case the bank fails.

Money market funds (MMFs), on the other hand, are not as ironclad. They are mutual funds that invest in a pool of highly liquid, low-risk securities like short-term government bonds, commercial paper issued by corporations, and certificates of deposit. While MMFs typically invest in safe assets, their returns are not guaranteed.

The value of your investment can fluctuate slightly based on the performance of the underlying securities. However, MMFs benefit from diversification, meaning your money is not tied to the fortunes of a single issuer, as in the case of Termed Deposits where you are completely exposed to the Bank. This can offer some protection against unexpected losses in the case of a bank failure.

 The Liquidity Lowdown: Accessing Your Cash

Termed deposits offer a clear advantage in terms of guaranteed returns, but they come at the cost of flexibility. Your money is locked in for the chosen term. Early withdrawal typically comes with a penalty (here in Nigeria ranges from 10% to 40%), which can eat into your potential earnings. This makes TDs a good option for money you know you won't need for a set period.

MMFs, on the other hand, are known for their high liquidity. You can typically redeem your shares on any business day at the current net asset value (NAV), which reflects the value of the underlying holdings. This makes them a good choice for parking your emergency fund or cash you might need for upcoming expenses.

The Yield Equation: Chasing Returns

Fixed deposit rates are typically set by the bank and can vary depending on the term length and current market conditions. Generally, longer terms translate to higher interest rates. However, TD rates tend to lag rising interest rates, meaning you might miss out on some potential gains.

MMF returns fluctuate based on the interest rates earned on the underlying securities. While they may not offer the highest yields, they can be more responsive to rising interest rates compared to TDs. However, there's always the possibility of the NAV dropping slightly, especially if the fund invests in lower-quality assets for higher returns.

Other Considerations

Because most financial institutions are private, and do not share their financial reports to the public, it is difficult to determine the health of a financial institution. Typically, smaller financial institutions are riskier and make, and would usually offer higher interest rates on deposit. While yield seeking might entice investors, it is prudent to seek advice before making a deposit placement in a bank.

Money market funds are typically issued by asset management firms and charge a management fee on the fund. Fund Management fees vary and could be as high as 2% per annum, which include fund operating expenses and the fund manager’s fees, which could eat into your returns. It is prudent to purchase low-cost funds and check past performance relative to prevailing Treasury bill yield to ascertain the performance of the fund manager.

 The Final Choice: Tailoring Your Needs

Ultimately, the best choice between money market funds and fixed deposits depends on your individual circumstances and financial goals. Here's a quick breakdown to help you decide:

Choose Fixed Deposits if: You prioritize guaranteed returns and don't need immediate access to your money. You can tolerate a lower potential return for the security of deposit insurance.

Choose Money Market Funds if: You need easy access to your cash and value liquidity. You are comfortable with slight fluctuations in your returns in exchange for the potential for higher yields, especially in a rising interest rate environment.

Remember, diversification is key. You can even consider using a combination of both instruments to achieve a balance between security, liquidity, and potential returns.

	Money Market Mutual Funds	Termed Deposits
Returns	Tracks Treasury yield	Higher – But depends on issuing financial institution
	Varies during investment horizon	Fixed for term
Accessibility (liquidity)	High	High – but may vary depending on terms and institution health.
Need for funds	Uncertain	Set
Ideal Use	Best alternative to a checking account	Planned withdrawal Income investing alternative
Early Withdrawal	Free	Penalty Cost (25% industry median)
Taxes	Tax-free	10% Withholding Tax on earned interest