Money market mutual funds, as the name suggests, invest mostly in money market instruments. As per Sebi norms, these schemes must invest in money market instruments with maturity of up to one year. Money market instruments India typically are treasury bills, certificate of deposits, commercial paper, repurchase agreements, and so on.
What is so special about these schemes?
These schemes are considered ideal for investors with little very little tolerance for risk. Since they invest in instruments with short tenure, they are not very sensitive to interest rate changes in the economy. They are also relatively safer because the money market instruments have lower risk.
If you are a conservative investor looking to park money for up to a year, you may consider investing your money in these schemes. Note, it is not advisable to park money needed for very short-term needs in these funds. Stick to overnight funds and liquid funds for your very short-term goals.
Note, though these schemes are relatively safer, do not ignore the risks associated with them completely. All the risks associated with debt funds such as credit risk, interest rate risk, etc, are applicable to these schemes, too.
Always choose a mutual fund house with a good track record managing debt mutual funds. Also, look at the strategy of the fund manager. You should be extra careful about whether he is sticking to investments with short tenure and good credit rating.
Also, look at the expense ratio. Expense ratio is the fee charged by the fund house to manage the money. Since you are earning modest returns in debt mutual funds, it is very important to choose a scheme with lower expense ratio.
Money market funds are taxed like debt schemes. That is, if you sell investments before three years, the returns would be added to your income and taxed according to the income tax slab applicable to you. If you sell your investments after three years, returns would be taxed at long-term capital gains tax of 20% with indexation benefit. Indexation helps to bring down the purchase cost and it brings down taxes, especially in an inflationary scenario.