Financial Literacy Friday: Money Markets
This week’s edition of Financial Literacy Friday focuses on the money market and how it differs from capital markets. I will also take a look at money market funds as that’s generally what people think of when they hear money market. The money market and money market funds can be very important, especially if you’re looking for a place to hold your liquid assets and want a return that beats the generic savings account.
Money Market vs Capital Market
Financial markets are much like normal markets, they bring buyers and sellers together in order to move goods back and forth. While the goods being traded are stocks, bonds, and other assets, the concept is the same. Capital markets contain the stock and bond markets and are generally focused on longer term investments with a higher degree of risk to the investor. These markets are the ones that are closely followed and what most people think of when someone says the phrase “How is the market doing today?”.
The money market operates the same way, but contains assets that are far more liquid (easy to move or redeem for cash) and with shorter time horizons. These investments are usually a year or less and contain deposits and short term loans between banks. Because of the shorter terms and the higher quality of investments, the money market is seen as very stable and low risk which can provide confidence to those who are risk averse that they won’t lose their money. The return is far less on their investments, but you’re sacrificing the return potential of the capital markets for the safety and liquidity of the money market.
Money Market Funds
Money market funds which is what most people think of when they hear money market are simply funds that contain the instruments traded on the money market. The goal of these funds is to provide a good sampling of what’s being traded on the money markets, but allow for maximum liquidity with a small amount of return. Because of the safety of the money market and how easy it is to get in and out of, these money market funds act as a great place to park money in order to keep it safe from downturns in the capital markets. However, there are some downsides that need to kept in mind when investing in money market funds. You need to look at the return as compared to inflation, because if your investment is returning 3% and inflation is at 4% then you’re losing purchasing power every year. The other component of this is what fees you’re paying, as even small fees can create a big dent in your returns if you’re only getting 3% to begin with. There are many angles to fully investigate before making a decision to invest in money market funds, but they can be an important addition to your financial well-being.
If you have questions about which money market funds to add to your portfolio or if they are better than other options for holding cash, let me know and we can discuss how they fit into your financial strategy.