Money markets may not be the most discussed topic in the world of finance but play a critical role in the global economy. You see, money markets are where businesses, governments, and financial institutions go to get short-term financing for their operations.
It’s like a bustling marketplace where buyers and sellers come together to trade low-risk investments like Treasury bills and certificates of deposit.
However, how does all this information help the average you, who is willing to invest your hard-earned cash in such an investment?
This post aims to dive into money markets, a list of pros and cons you should know before jumping into this niche of investment, and general dynamics.
What are Money Markets?
Money Markets are safe, liquid investments well suited for small investors. These investors typically invest in steady funds, such as treasury bills, certificates of deposits, and commercial paper.
For instance, if you want to save up for a trip to a dream destination, choosing a money market will be a good option for you. This is because it’s relatively low-risk compared to other forms of investment, and has higher interest rates than traditional lending systems.
Money Market funds are short-term, and therefore, funds are invested here for a limited time. Treasury Funds, and Commercial paper typically last ≤ 1 year and 270 days respectively.
If you invest your money and you end up wishing to withdraw earlier than anticipated, you have the option of ‘selling the fund’ usually for a smaller profit, than the one anticipated after the entire anticipated period of investment.
Treasury bills, are a secure, short-term investment, offering you returns after a relatively short commitment of funds. Treasury bill rates in Kenya are attractive, providing an excellent investment opportunity as they are auctioned each week.
Commercial Paper is an unsecured form of promissory note that pays a fixed interest rate. It’s typically issued by large banks or corporations to cover short-term receivables and meet short-term financial obligations, such as funding for a new project.
Certificates of deposit, are savings account that holds a fixed amount of money for a fixed period, such as 6 months, 1 year, or 5 years, and in exchange, the issuing bank pays interest.
With definitions out of the way, here is one very important clarification:
Are Money Markets Similar to Money Market Funds?
No, they are not!
In Money Markets, you as the investor, trade in short-term debt securities like Treasury bills and commercial paper. These are generally low-risk investments. However, Money Market Funds (MMFs) are a type of mutual fund that invests in these securities – on your behalf. This gives investors a safe place to park their cash and earn a modest rate of return.
Other types of mutual funds include:
- Equity funds
- Fixed income funds
- Balanced funds
- Index funds
- Sector funds
- Alternative funds
What are the benefits of investing in money markets?
Before jumping into the investment procedure, let’s list down the advantages of money markets.
- They are a relatively low-risk way to generate a return as the per-value is preserved in the same way as bonds. This makes them attractive during times of market uncertainty.
- As they are a short-term and less risky investment, the level of return for an investor tends to be when tax and inflation have been taken into account.
- Highly liquid.
- Higher returns than most bank accounts.
Cons of Money Markets
- It often involves large sums of money to invest in money markets instruments directly. Therefore, it tends to be institutional investors like pension funds and insurance companies who buy them. For an average investor, you will have to look for a channel such as a mutual fund, for you to be able to invest in these money markets.
- While money market investments are generally considered low-risk, they also tend to offer lower returns compared to other investment options, such as stocks or bonds.
As you delve into money markets, weigh your options and make sure you understand the dynamics of what you are venturing into. Understand the risks associated with any form of investment, and assess whether the pros are worth the ride.