A Look at the Effects of Inflation on Money Market Funds

Money market funds are a safe and secure investment vehicle in which you can grow your wealth or put your money in the short term.

Inflation can be defined as a persistent increase in the price level over time, and according to Cytonn Investments, there are two types of inflation that affect money market funds; cost-push and demand-pull inflation.

Cost-push inflation arises from a decline in the aggregate supply due to an increase in the costs of the factors of production such as wages and raw materials.

The increased cost of production is then transmitted to the final consumer in order for the companies to maintain their profit margins leading to an overall rise in prices in the market.

Demand-pull inflation, on the other hand, is as a result of the increased money supply due to a number of factors e.g. increased government spending which increases aggregate demand, resulting in a situation of too much money being spent chasing too few goods, which causes the prices of goods to rise.

Due to the rise in the price of commodities, inflation tends to erode the purchasing power of money. To understand the effects of inflation on the returns on Money market Funds, we first have to focus on the real rate of return.

The real rate of return can be defined as the annualized return on investments adjusted for inflation. For an investor, the real rate of return is usually important as it gives a clear picture of the investment value and whether it has been eroded by inflation.

In simpler terms, if the level of inflation is higher than the nominal rate of return earned from an investment, it means that the return has been eroded by inflation, and in extension the purchasing power of your money, thus you cannot afford the same quantity and quality of goods with the amounts as before.

In Kenya, Money Market Funds continue to be the most popular investment product with the assets under management (AUM) held by Money Market Funds having grown by 8.9 percent to 48.5 billion shillings in 2018 from  44.5 billion shillings recorded in 2017.

The average yield for the top five MMFs in 2018 was 10.3 percent, with inflation averaging at 4.7 percent meaning the real rate of return on average was 5.6 percent, an indication that Money Market Funds still remain a safe investment haven in our economy.

Read Also: All You Need to Know to Start Investing in Money Market Funds