The money market is a subdivision of the fixed income market. Normally people think of the term ‘fixed income’ identical to bonds. A bond is only one type of fixed income security. The difference between the money market and the bond market is that the money market specializes in very short-term debt securities i.e., debt that matures in less than a year. The money market investments are also called cash investments because of their short maturities.
Money market securities are essentially IOUs issued by governments, financial institutions, and large corporations. These instruments are considered very liquid and hence safe. Since, they are extremely conservative, money market securities offer significantly lower return than most other securities. One of the main differences between the money market and the stock market is that most money market securities trade in very high denominations. Furthermore, the money market is a dealer market, which means that firms buy and sell securities in their own accounts, at their own risk. This limits the access of the individual investor to the inventory held by their broker. When you compare this to the stock market where a broker receives commission to act as an agent, while the investor takes the risk of holding the stock. Another characteristic of a dealer market is the lack of a central trading floor or exchange. Deals are transacted over the phone or through electronic systems.
The easiest way for us to gain access to the money market is through a broker or by using money market mutual funds. These funds pool together the assets of thousands of investors in order to buy the money market securities on their behalf. However, some money market instruments, like treasury bills, may be purchased directly.
The types of debt securities held by money market mutual funds are required by federal regulation to be very short in maturity and high in credit quality. All money market funds comply with industry-standard regulatory requirements regarding the quality, maturity, liquidity, and diversification of the fund’s investments. Investments can include short-term U.S. Treasury securities, federal agency notes, Euro-dollar deposits, repurchase agreements, certificates of deposit, corporate commercial paper, and obligations of states, cities, or other types of municipal agencies depending on the focus of the fund.
Money market funds may be appropriate for customers who:
- Have an investment goal with a short-time goal
- Have a low tolerance for volatility, or are looking to diversify with a more conservative investment
- Need the investment to be extremely liquid
While the returns on money market funds are generally not as high as those of other types of fixed income funds, such as bond funds, they do seek to provide stability, and can therefore play an important role in your portfolio. Investors can use money market funds in a few ways:
- To offset the typically greater volatility of bond and equity investments
- As short-duration investments for assets that may be needed in the near term (such as an emergency fund)
- As a holding place for assets while waiting for other investment opportunities to arise (such as in the core position for your brokerage account)
A money market fund is a type of fixed income mutual fund with very severe maturity, credit quality, diversification, and liquidity requirements intended to help it achieve its goals of principal preservation and daily access for investors. Customers should always determine before, picking a money market fund whether its characteristics align with their investment objectives and strategy.
The next question you may ask are what are the advantages of money market funds? They offer stability. Money market mutual funds are considered to be one of the least volatile types of mutual fund investments. Liquidity is the next advantage. It’s not very difficult to settle your brokerage account trades in other investments, or recover funds from a money market mutual fund that are generally assets available by the next business day. The feature an investor looks for before investing, is security of their investments. The money markets offer security. The funds are required by federal regulations to invest in short-maturity, low-risk investments, making them less prone to market fluctuations than many other types of investments.
They are also of a shorter duration is so short, they are typically subject to less interest rate risk than longer-maturing bond fund investments. Some money market funds invest in securities whose interest payments are typically exempt from federal, and in some cases, state income taxes, and these funds can be a potential source of stable, tax-efficient income.
We also need to be aware of the risks of money market funds. There is some credit risk.
Unlike typical fixed deposits or savings accounts, money market mutual funds are not that safe, although money market mutual funds invest in high-quality securities and seek to preserve the value of your investment, there is always the risk that you could lose money, and there is no guarantee that you will receive all your money per share, when you redeem your shares. You need to consider the silent killer in other words, inflation. Because of the safety and short-term nature of the underlying investments, money market mutual fund returns tend to be lower than those of more volatile investments such as typical stock and bond mutual funds, creating the risk that the rate of return may not keep pace with inflation.
People living in foreign countries can be affected by adverse political, regulatory, market, or economic developments in those countries. Changes in government regulations, interest rates, and economic downturns can have a significant negative effect on issuers in the financial services sector, including the price of their securities or their ability to meet their payment obligations.