分类： Capital Funds

How to choose funds that will make money is a primary goal for many investors, but how should one go about selecting funds?

This article shares three steps for selecting fund investments, which I believe are fundamental principles when starting the fund selection process. These steps aim to provide some criteria for consideration, helping you make judgments that suit your needs when choosing funds.

 

Step 1: Decide asset allocation ratio.

Before choosing which fund to invest in, the primary step isn’t about looking at metrics like Sharpe ratio, Beta, or standard deviation, or immediately diving into monthly fund reports. It’s about first “deciding asset allocation ratios.”

I’ve mentioned before, while each asset category covers various investments, assets within the same category tend to have similar risk-return characteristics. Some assets move in tandem, while others have low or even opposite correlations. Asset allocation aims to invest funds across different types of assets (like stocks, bonds) to significantly reduce volatility without compromising returns too much.

Rather than concentrating investments in one asset type, effective asset allocation helps mitigate significant damage from market ‘black swan’ events.

In essence, determining the proportion of each asset based on one’s risk tolerance is a crucial consideration to mitigate investment risks arising from market uncertainties.

 

Step 2: Decide fund diversification level

Concentrating investments in a single asset isn’t a problem, but excessive concentration in an industry category might pose cyclical risks.

This means that when an entire industry experiences a prolonged period of decline, even if you hold a diversified portfolio, it might still be concentrated within a specific range.

For example, if you buy stocks from multiple companies in the technology sector, you may have diversified into 10-20 different stocks. However, if there’s a global pandemic like the recent one or a black swan event that impacts the entire tech industry, all stocks within the same industry will fall, including bonds and REITs (such as data centers) that are highly related to the tech industry. Under systemic risk, you may still need to endure significant volatility.

A common misconception about diversified investing is that diversifying the targets is sufficient. However, true diversified investment logic should include three levels of diversification:

Asset Diversification: Holding different types of assets, such as stocks, government bonds, investment-grade corporate bonds, gold, cash, etc.

Industry Diversification: To avoid the impact of a single specific industry cycle, invest in national or regional ETFs or funds, typically diversifying across various industries of that country/region.

Stock Diversification: Investing in 1-2 different ETFs or funds with different characteristics, or assembling a diversified investment portfolio yourself.

Diversified investing is just one of the investment options. Everyone’s situation and risk tolerance differ. If you have enough time to research and are confident in your judgment, you might also consider concentrated investments.

For most people, diversified investing may not always be better, but it is certainly not a worse option.

 

Step 3: Screening Fund Composition, Fees and Performance

The essence of a fund lies in pooling together funds from a group of individuals, managed collectively by fund managers to seek higher investment returns. It’s one of many investment tools, much like ETFs.

If you opt to use funds as an investment tool, the following sequence introduces indicators such as fund composition, fees, performance, and more. These aid in selecting a suitable fund for your needs.

 

Step 1: Observing Fund Components

Each fund usually lists its top 10 or top 5 holdings, which can be found on the fund’s official website or in its monthly reports. When you invest in a particular fund, its holdings represent your investment portfolio. Hence, it’s crucial to observe whether the manager’s stock selection aligns with your expectations. Unless we’re very familiar with a fund manager, it’s unlikely we’ll know their team’s investment strategy. However, we can gain insights through their stock selections.

When screening funds, consider these three questions to assess if a fund matches your investment style:

Are there any holdings in the top 10 that you don’t agree with?

What are the respective weightings of the top 10 holdings? Do they match your expectations?

Where does the recent performance come from in terms of stock selection? Do you agree with this performance?

Remember, whether it’s an ETF or mutual fund, you’re essentially paying someone to manage your assets. Therefore, it’s crucial to understand their management style and decision-making process. Reviewing fund components helps us understand their decision-making logic.

 

Step 2: Understanding Fund Fees

When buying or selling funds, you may encounter several main fees, which can be found on the fund’s official website or in monthly reports. While assessing a fund, besides examining if its performance meets expectations, pay attention to the associated fees. High fund fees might impact the fund’s returns. Don’t assume that earning more than the fees is sufficient; even small percentage differences can have a significant impact as the amount grows.

Especially for products with lower investment returns, high fees can proportionally increase the total cost, making fee levels crucial to consider.

It’s important to note that these are not the only fees; there are also internal expenses like the fund’s trading costs. Funds intended for long-term investment usually follow the guideline of holding for extended periods and avoiding frequent trading. Funds with high turnover rates and frequent stock turnover might significantly elevate costs. While short-term gains might seem promising, it’s essential to question if it’s beneficial in the long run.

 

Step 3: Screening Fund Performance

Many people tend to assess a fund’s performance as the first step, but I believe performance should be the final consideration. After agreeing on investment style and understanding fee structures, then delve into performance assessment.

After all, a fund with stellar performance might be chasing the trend with various hot stocks at the moment, which might not align with your long-term investment strategy.

Observing a fund’s long-term performance entails two key aspects:

1. Assess whether the fund’s annual performance has consistently outperformed the corresponding index.

For instance, a tech stock fund should be compared to growth stock indices to gauge relevance. A high-yield bond fund should be compared to high-yield bond indices to derive meaningful insights. While it’s challenging for even exceptional funds to outperform indices annually, observing annual performance provides insights into its strategy’s quality.

2. Observe performance during both bullish and bearish periods, particularly in bear markets.

For instance, in the stock market, during major downturns like 2008, 2018, 2022, observe the fund’s performance during these years. Pay attention to years with significantly high profits or losses, especially when there’s a substantial deviation from the index.

This observation helps in understanding the fund’s risk and strategy, aiding in determining its suitability for you.

Of course, funds need to have a sufficiently long track record for substantial data. For funds with less than a year of establishment, it’s advisable to observe for a longer period.

When assessing performance, focus not on net asset value but on performance or cumulative fund-level returns.

Asset Allocation Defined: Achieving a desired risk and return configuration by investing funds across different types of asset categories.

 

1. The Goal of Asset Allocation: To reduce uncertainty (minimize volatility risk) at the expense of a small portion of returns.

Alternatively, it can be said: To enhance returns without increasing risk.

What does it mean to achieve the desired risk return through asset allocation?

Stocks offer the highest returns over the long term. Generally, decent investment results can be achieved simply by buying and holding (Buy & Hold) stocks, or investing regularly and consistently.

However, stocks trend upward over the long term experiencing significant volatility. Thus, in the investment process, the timing of entry and exit can greatly impact the outcome. Even with an extended timeline, reasonable returns are possible, but the interim process might involve substantial psychological stress. Imagine the feeling of watching a retirement fund of 5 a year.

But if investing in assets with lower volatility, such as bonds, although the fluctuations are relatively stable and not drastic, the returns are much lower. You might be dissatisfied with the returns, and it’s challenging to predict whether holding a single asset (even bonds) might suddenly encounter a black swan event causing significant loss.

Hence, it was discovered that holding different types of assets (stocks, bonds) simultaneously could significantly reduce volatility without decreasing the rate of return too much.

The process of selecting and allocating proportions of different asset types is known as “Asset Allocation.”

 

2. The Principle of Asset Allocation: Trends of Two assets having “negative correlation” or “no correlation”.

If stocks fall and bonds rise, or vice versa, this relationship is known as a “negative correlation.”

This negative correlation is not a precise statistical correlation coefficient but a general phenomenon. In asset allocation, we do not require the trends to be opposite or utterly unrelated. It suffices if “other assets remain unaffected when one asset experiences a significant drop,” achieving the goal of reducing volatility.

Besides stocks, other assets exhibit similar patterns. For example, the trends of gold and other precious metals are not closely related to the stock and bond markets, meaning their rises and falls are unrelated and can be considered “no correlation,” indicating very low relatedness.

The performance of Real Estate Investment Trusts (REITs) is somewhat similar to stocks but not identical.

Thus, when funds are distributed across different asset categories, even if a single asset (e.g., stocks) experiences a significant drop, other assets may be less affected or even rise, ultimately leading to reduced volatility. However, the long-term rate of return may not decrease too much.

In practice, most different asset classes are configured using assets with low correlation, and besides stocks and bonds, few have negative correlation characteristics.

Additionally, since the volatility of stocks is several times that of bonds, unless bonds have a high allocation proportion or use more volatile long-term bonds, their ability to reduce volatility is limited. However, this is usually sufficient for most investors.

 

3. The Asset’s Returns Must Trend Upwards in the Long Term.

Assets that can generate positive returns over the long term must be chosen for allocation.

Stocks, bonds, and real estate (REITs) are unquestionable. More controversial are commodity assets (Commodities), including gold, oil, precious metals, agricultural products, etc. The price trends of these assets are more influenced by supply and demand, and they partly serve as inflation hedges. In the long term, their returns are relatively lower than other asset classes, and they are more volatile.

However, as their trends are mostly unrelated to most stocks and bonds, they are effective in reducing overall volatility. They are not essential for asset allocation, but many renowned asset managers (like Yale University’s endowment) allocate a portion to commodity assets.

 

4. The Focus of Asset Allocation is “Reducing Volatility,” Not “Pursuing High Returns.”

Many people with limited funds seek high returns but fear risks, wondering if it’s possible to have high returns with low risk.

This is not achievable. Asset allocation is about sacrificing some rate of return (lower than investing solely in stocks) to significantly reduce uncertainty.

When your investment horizon is long, and you don’t have a lot of funds, pursuing high returns through long-term stock market investment might be the best. If you can disregard the interim volatility, asset allocation might not be necessary.

Conversely, if you are easily affected by volatility, have a shorter investment period, or are investing a large amount, then asset allocation becomes crucial. It can significantly reduce volatility issues, but the focus should not be on high returns but rather on reducing volatility.

 

5. Long-Term Investment is Still Needed to Achieve High Certainty Results.

When holding highly volatile assets for a short period, there’s a risk of buying high and selling low.

After asset allocation, volatility decreases, so there’s less fear of buying at the peak for short-term investments.

However, volatility cannot be eliminated. Extending the investment period increases certainty, and a minimum of 5 years or longer is recommended for more certain outcomes.

This leads to a contradiction: If one can hold long-term, should the interim volatility be disregarded?

For example, if holding stocks long-term yields better returns, is asset allocation unnecessary?

It depends on one’s psychological resilience and the size of their funds. If the funds are substantial and volatility is a concern, then it’s even more important to reduce volatility risk through asset allocation.

Conversely, those who are less concerned about the process and have a higher risk tolerance can hold a higher proportion of stocks.

 

6. Understanding Your Investments.

If you create a certain asset allocation and ask me, “Is this allocation ratio appropriate?”

My first question would be, “Do you understand your investment?”

You might hope for a standard answer on how to operate best, but there is no standard answer.

Firstly, we only know the past and can only speculate, not predict the future. Secondly, any good investment might be abandoned halfway due to volatility if you don’t fully understand its characteristics.

I believe that the characteristics of assets, when extended over time, become quite apparent, including their volatility, cyclical nature, and long-term rate of return.

Only when you know what you are buying can you hold it for the long term.

“Before starting long-term investing, what should I buy?” This is a question I have often received from many students. In fact, The most challenging aspect of long-term investing is not how to start correctly, but how to complete the process of long-term investment properly. Therefore, the priority is not what to buy, but to understand the process of long-term investment, to understand oneself, and to make proper asset allocation, to complete one’s journey of long-term investment. This article shares three key considerations for long-term investing, including understanding the market, understanding oneself, and understanding the tools and methods, to evaluate the long-term investment approach that suits you best.

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The First Key Consideration: Understanding the Market

1. Understand the important basic asset types in the financial market and choose assets with long-term upward trends.

Important asset categories in the financial market include stocks, bonds, gold, REITs, commodities, raw materials, etc.

However, not every asset is suitable for long-term investment. Priority should be given to assets with a long-term upward trend.

For most investors, the most basic and important assets are stocks and bonds.

Stocks: Stocks represent ownership in a company. Companies operate to provide products and services and generate profits, and stock investors share in these earnings.

Bonds: Bonds are certificates of debt. By lending money to governments or companies through bonds, investors can receive interest and reclaim the principal upon maturity.

Because stocks can continuously create earnings, and bonds consistently issue interest, stocks, and bonds as a whole tend to show a long-term upward trend over longer periods.

Conversely, assets like commodities and raw materials often have greater volatility than the stock market. They do not generate earnings or interest and lack upward growth characteristics, making them less suitable for long-term investment and more often used for short-term or swing trading.

2. Different assets have different investment returns and risk characteristics.

Although companies create earnings and bonds pay interest, this does not mean that stocks and bonds only rise and never fall. The reason is that at any point in time, the price people are willing to pay for an asset is influenced by their judgment of the future and current market sentiment, causing fluctuations. The degree of fluctuation varies among different assets.

Bonds are more influenced by the current interest rate environment, so it’s not just historical returns that matter but rather recent years’ returns that are more relevant. Unlike the stock market, the bond market, except for long-term bonds and high-yield bonds which have greater volatility, experiences less drastic changes in the short term with medium and short-term government bonds and investment-grade bonds. Although overall returns are lower than the stock market, stability is relatively higher.

Statistically, even in a 40-year long-term investment in U.S. large-cap stocks, there may be downturns of up to -50%. The scale of drawdowns in the bond market, on average, is smaller than that in the stock market.

The need to withstand price volatility is a crucial characteristic of the financial market and something that long-term investors need to understand.

Before embarking on long-term investments, investors should comprehend the risk characteristics of the assets they invest in, assess the risks they might encounter throughout their investment, and know which tools are suitable for them.

 

The Second Key Consideration: Understanding Oneself

After understanding the various assets in the market and their risk-return profiles, the choice of which markets to invest in should be based on your own conditions and risk tolerance.

1. Understanding One’s Investment Goals

Goals such as accumulating retirement funds, saving for future college tuition for children, or a down payment for a house, may require selling and withdrawing funds at certain future points, or they may be under pressure not to incur significant losses.

The most common mistake in setting investment goals is the pursuit of high returns, with the belief that the higher the return, the better.

In investing, the potential for high returns is accompanied by high risks, which could also result in low returns or losses. Understanding one’s goals and how much risk one can tolerate is crucial in determining the right long-term investment asset allocation that suits you.

2. How Long Can Invest?

A principle of investing is to only use surplus money, as the investment plan needs to be halted when the funds are required for other purposes.

The shorter the investment period, the lower the risk of the investment should be chosen. The longer the investment period, the more feasible it is to choose higher-risk investments.

Generally, if the investment horizon is less than 5 years, it’s not advisable to choose high-risk investments. Although bearing lower risk might result in lower returns, the potential loss will also be smaller if the outcome is not as expected.

Conversely, if the investment period is longer, such as over 15 years, and you are willing to take on higher risk, you can choose higher-risk investments. Over a longer period, there’s a higher likelihood of achieving returns close to historical averages.

3. How Much Risk Volatility Can Tolerate?

Everyone’s ability to tolerate risk varies due to personal cash flow, age, and personality.

In investing, higher-risk asset classes include stocks, which historically, in some of the worst periods, have dropped by as much as -50%. For example, an investment of $1 million could drop to $500,000, or $20 million to $10 million. Although it might rise again later, the reality is that many people cannot endure such a process.

Once the price volatility exceeds your tolerance, it often means the end of your investment plan, rendering any long-term investment strategy meaningless.

Therefore, it’s important to understand your risk tolerance and control the risk within your capacity when investing.

4. How Much Time Do I Have to Research Investments?

Investors with ample time to research can employ completely different methods compared to those without time.

Those who have the time and ability to research might adopt active investment strategies; if you lack the time for research, you might consider passive or index investing, or entrusting a fund manager with the operation.

 

The Third Key Consideration: Understanding Investment Tools and Methods

1. Decide on Asset Allocation Proportions

Asset allocation is a method of controlling investment risk by distributing funds proportionally across different assets.

The goal of asset allocation is to reduce overall asset risk and increase investment certainty through the low or sometimes negative correlation between different assets. The allocation method varies depending on the investment period and risk tolerance.

For example, stocks are more volatile, while bonds are less so. Therefore, a combination of these two types of assets can be used, such as a typical proportion of 60% stocks and 40% bonds. Compared to investing solely in the stock market, this might result in slightly lower long-term returns, but the volatility will be much reduced, and the potential drawdown in any single year may also be smaller.

2. Decide on Investment Targets: Beginners Should Use Broadly Diversified Investment Tools

There are many diverse investment tools in the financial field, such as stocks, bonds, mutual funds, ETFs, etc.

It’s recommended for beginners to start with diversified fund tools, including mutual funds and index funds. Even with a small amount of capital, it’s possible to achieve broad diversification, avoiding severe losses due to misjudgment in a single stock or bond.

3. Choose Investment Methods

There are many ways to decide on the timing of purchases for long-term investment, but the most challenging aspect for beginners is disciplined adherence to the plan.

For beginners, the simplest method is regular fixed-amount investing.

As long as the chosen assets have a long-term upward trend, regular fixed-amount investing can average out the purchase price over time. Though it may not always buy at the lowest price, it also avoids buying at the highest, helping investors to invest with discipline.

 

Start Long-Term Investing with Simple Execution and Diversification of Risk!

The most challenging part of long-term investing is not how to select targets, but how to execute a long-term investment plan with discipline.

Before embarking on long-term investing, it is crucial to fully understand the market, especially stocks and bonds, and their long-term characteristics and risks, so you can anticipate the fluctuations that might occur during the investment process.

It is also essential to have a good understanding of yourself before long-term investing, including your investment horizon and risk tolerance, to avoid making decisions that exceed your risk-bearing capacity in pursuit of returns.

After understanding the market and yourself, choose the appropriate asset allocation tools and decide the investment proportion for assets like stocks and bonds. It is recommended for beginners to start with tools that offer broad diversification and regular fixed-amount investing. Many fund tools currently provide the effects of diversified investment and regular fixed-amount investing.

After accumulating some investment experience, if you have your own opinions, you can allocate a portion of your funds to supplement and strengthen certain types of targets.

Money market funds, known for their low risk, low transaction costs, and returns that are typically better than regular savings accounts, along with the flexibility of buying and selling at any time without the long-term commitment required for fixed deposits, are a popular tool for parking idle funds.

However, are money market funds guaranteed to preserve capital? Under what circumstances might they incur losses?

In theory, money market funds are capital-preserving, but there are always exceptions in the financial market.

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1. Why Do Money Market Funds Incur Losses?

A Money Market Fund (MMF) invests investors’ funds in a variety of high-quality, highly liquid short-term bonds, earning almost risk-free short-term interest. The returns offered by money market funds are generally close to those of bank fixed deposits.

Internationally, discussions about money market funds mainly focus on U.S. dollar money market funds, although different currencies also have their respective money market funds. The following discussion about the losses of money market funds primarily refers to the most important U.S. dollar money market funds.

Money market funds are generally considered a safe place to store idle or short-term funds, characterized by low risk and low returns, low transaction costs, strong liquidity, and high stability.

The biggest difference between money market funds and bank fixed deposits is that money market funds are not protected by bank deposit insurance (such as the FDIC in the United States, which guarantees up to $250,000 per account per bank). This means that while bank fixed deposits are protected up to a certain amount, money market funds may incur losses.

The investment objective of money market funds is to pursue safety and stability, aiming never to incur losses.

Taking the most mainstream U.S. dollar money market funds in the United States as an example, these funds aim to maintain their net asset value (NAV) at $1.

If the NAV of a money market fund falls below $1, it means that investors will not get back $1 for every $1 invested, incurring losses.

A significant global incident occurred in 2008 with the bankruptcy of Lehman Brothers, when the Reserve Primary Fund’s NAV fell to $0.97, equivalent to a loss of 3%.

 

2. Under What Circumstances Can Money Market Funds Incur a Loss of Principal?

Money market funds invest investors’ money in “highly liquid and safe short-term notes,” simply put, these are investment targets that mature within a year, are extremely safe, can be easily liquidated, and generate interest. These include Bankers’ Acceptances, Certificates of Deposits, Commercial Papers, Repurchase Agreements, and Short-term Government Debt Issues.

From these instruments, it is evident that although these short-term notes are extremely safe, they are not 100% secure. For instance, commercial papers still carry a default risk.

However, money market funds do not invest solely in commercial papers. The investment in commercial papers is also diversified across many companies. Therefore, a default in the commercial papers of one company would not have a drastic impact, and the net investment value would not plummet from 1 to 0. The most severe case in the history of U.S. dollar money market funds was a drop from 1 to about 0.97, a loss of approximately 3%. In such extreme situations, where these highly regarded safe investment tools are affected, governments usually intervene immediately to prevent a collapse of the entire financial system.

Generally, money market funds may incur losses in situations such as:

The short-term papers they purchase default.

Sudden and significant increases in interest rates, caused bond prices to plummet.

Large-scale redemptions by investors due to panic, force the sale of bonds at lower prices before maturity.

Notes:

Defaults on short-term papers are rare, but not impossible. These commercial papers usually constitute a small, well-diversified portion of money market funds.

In the event of a significant rise in interest rates, though it could cause a substantial drop in bond prices, short-term bonds have very short durations, typically ranging from a few days to a few weeks, and are almost unaffected by interest rate risks. Even if there is a temporary price impact, the principal can still be recovered upon maturity after a few days or weeks. Hence, temporary price fluctuations do not affect their value significantly.

However, it’s essential to remember that money market funds are still funds. If redemptions occur, the fund managers need to sell their positions. While short-term bonds and notes are highly liquid, there might be times when liquidity is exceptionally low. If investors redeem in large numbers during such times, even if the market might recover later, the fund managers have no choice but to sell and stop losses.

 

3. The Safety of Money Market Funds

Money market funds are considered highly safe due to the following characteristics:

Characteristic 1: Short-Term Investments, Low-Interest Rate Risk

Money market funds invest in instruments that mature within a year, with a weighted average portfolio duration of 90 days or shorter. The extremely short duration allows fund managers to quickly adjust to the ever-changing interest rate environment, thereby reducing interest rate risk.

Characteristic 2: Investments in High Credit Rating Debt, Low Default Risk

Money market funds invest only in the highest credit rating debt, usually AAA-rated. These instruments have a low risk of default.

Characteristic 3: Diversified Investment Targets, Reduced Risk

Besides government-issued securities, money market funds cannot invest more than 5% of their funds in any single issuing institution.

This diversification means that if a single investment target experiences a credit rating downgrade, the impact on the entire fund will be within 5%.

Characteristic 4: Tied to the Reputation of Fund Companies

As the participants in the money market fund market are large, professional institutions, if these companies’ money market funds incur losses, it would severely damage their reputation. Historically, losses in such funds have been extremely rare. Therefore, companies issuing money market funds strive to avoid losses, enhancing investor safety.

Characteristic 5: Impact on Financial Market Stability

Since money market funds are considered very safe, if they incur losses, it would likely lead to mass redemptions, similar to a bank run, with unimaginable consequences.

Therefore, based on past experiences, if money market funds suffer losses, peers or governments are likely to intervene, which further enhances people’s expectations of the safety of money market funds.

 

4. Crises in Money Market Funds: A Summary

Money market funds originated in 1970, and in the more than 50 years since then, there have only been two instances where the net asset value (NAV) of a fund fell below $1.

Crisis 1: 1994, Small Regional Money Fund Falls Below $1

Whenever a money fund faces issues, its issuing institution usually makes every effort to rescue it to maintain the company’s reputation, which is why losses in money funds are rare.

The first recorded loss in history occurred in 1994 when a small regional money fund’s share price fell below $1. However, due to its small size, it was quickly rescued without causing a significant impact.

Crisis 2: 2008, Lehman Brothers’ Bankruptcy Causes Reserve Primary Fund to Drop Below $1

Reserve, a company specializing in money market funds based in New York, had $64.8 billion in assets in its Reserve Primary Fund in 2008.

At that time, the fund held $785 million in commercial papers issued by Lehman Brothers, constituting only about 1.21% of the fund’s total assets.

In 2008, during the financial crisis, Lehman Brothers declared bankruptcy on September 15th, making the commercial papers held by the Reserve Primary Fund worthless overnight. This caused the fund’s NAV to fall to 97 cents, meaning an investment of $1 could only retrieve 97 cents.

Worse still, due to investor concerns about the fund’s losses, nearly two-thirds of the fund was redeemed within 24 hours.

Unable to meet these redemption requests, the fund froze redemptions for up to seven days and was forced to suspend operations and begin liquidation.

The collapse of the money market fund had a significant impact on the entire market. Even those money market funds not affected by Lehman Brothers faced massive redemptions due to investor panic.

Consequently, more than a dozen fund companies were forced to intervene, providing financial support to money market funds to prevent them from falling below the $1 threshold.

Eventually, the U.S. government stepped in.

The U.S. Treasury Department offered a temporary guarantee program for money market funds, assuring investors that the value of each share they held in money market funds as of the close on September 19, 2008, would be maintained at $1 per share.

This incident also created an expectation: if money market funds were to experience such a disaster again, the government would step in to rescue them.

 

5. Risks of Investing in Money Market Funds

The risks involved in investing in money market funds include:

Sudden significant changes in interest rates, credit rating downgrades of multiple companies, and company defaults.

Mass redemptions in the market due to panic.

Market interest rates (such as the Federal Funds Rate) fall below the fund’s expense ratio, potentially causing losses.

Generally, U.S. dollar money market funds are considered risk-free, as their safety is akin to government bonds and bank fixed deposits. If they were to incur significant losses, it would be a problem as serious as a default on U.S. government bonds or a reduction in bank fixed deposits. We cannot say that these risks are impossible, but the probability of their occurrence is indeed very low, usually only in extremely unusual circumstances.

Of course, money market funds in currencies other than the U.S. dollar might not be as safe. This is similar to the fact that government bonds from countries other than the United States may not have as high a credit rating.

6. Considerations Before Investing in Money Market Funds

6.1 Review the assets held by the fund. If you are not clear about what you are investing in, it is best not to invest.

6.2 Look for funds with lower expense ratios. Lower expenses can yield higher potential returns without adding extra risk.

6.3 Prefer larger companies. Compared to smaller companies, larger companies typically have more abundant funds and are better able to withstand short-term fluctuations. Therefore, all else being equal, the larger the company, the better.

6.4 Diversify your portfolio. Spreading your money across different asset classes can prevent personal financial difficulties due to issues with one particular asset.

Although it is generally believed that the likelihood of losses in money market funds is minimal, money market funds are not limited to just the U.S. dollar; there are funds in various other currencies as well. Not every country’s government bonds are as safe as those of the United States, so it is still necessary to evaluate based on the specific investment target you choose.