A crucial step in building a sound financial plan is ensuring you have access to cash when you need it, but that doesn’t mean you have to keep that cash in a bank account earning modest interest. For investors looking to maintain a certain level of liquidity while earning a greater return than a savings account can provide, money market investments may be worth considering.
But what exactly is the money market and what types of investments are included in it?
What is the Money Market?
The money market is comprised of short-term debt instruments from Treasury bills and commercial paper to savings accounts and certificates of deposit (CDs). In addition to having short maturities, these investments are characterized by their high liquidity, low risk, and relatively modest yields compared to some other securities.
For most individuals, investing in money markets means investing in a money market fund or bank account that contains a basket of these debt instruments. The money markets can be a source of income, diversification, and liquidity and thus play an important role in many investors’ portfolios.
Financial Instruments in the Money Market
There are many types of investments within the money market. Here are some of the more prevalent ones to consider.
• Treasury Bills
Treasury bills are debt securities issued by the US Treasury with maturities ranging from four weeks to one year. Investors purchase these securities at a discount and receive their par value (full value) upon maturity. The difference between the purchase price and the price they receive upon maturity is what the investor earns. To illustrate, an investor pays $950 for a 6-month T-bill with a par value of $1000. When the bill reaches maturity in 6 months, the investor receives $1000 for a profit of $50. This payment is considered the interest earned on the bill.
Because they’re backed by the full faith and credit of the US government, T-bills are considered to be among the most stable investments. They can be purchased directly from the US Treasury or accessed indirectly through a money market fund or account.
• Certificate of Deposits (CDs)
CDs are financial products sold by banks and other financial institutions that pay interest on a lump sum of cash over a specified period. The maturity of a CD can be anywhere from three months to five years, and there may be a penalty for accessing your cash prior to the maturity date. However, CDs can offer higher yields than savings accounts to make up for being less liquid and they’re insured by the federal government, which makes them a stable investment.
• Commercial Paper
Commercial paper refers to unsecured loans issued by companies or financial institutions looking to fulfill short-term cash needs. These contracts tend to have maturities averaging 30 days and no longer than 270 days. Similar to Treasury bills, commercial paper is bought at a discount relative to its face value and investors earn a profit from the difference between these two prices.
Commercial paper contracts start at $100,000 or more and require the issuer to have a strong credit rating. As a result, many individual investors choose to purchase CPs through money market mutual funds.
• Money Market Funds
Investors can gain exposure to the money market by acquiring shares of a money market mutual fund. These funds trade a high volume of low-risk, short-duration debt instruments (such as the ones described above) in addition to holding cash and cash equivalents. A number of different money market funds exist to meet different investors’ needs – some may hold primarily US Treasuries while others focus on tax-exempt securities.
Money market funds can provide investors with liquidity for when they need access to cash while offering higher yields than saving accounts.
• Money Market Accounts
Money market accounts differ from money market funds in that they are a type of savings account set up at banks that are federally insured. These accounts often come with higher minimum balance requirements but can offer higher yields than other types of savings accounts depending on the bank. Eligible accounts are insured by the FDIC up to $250,000 for each depositor.
While many money market accounts may come with debit cards and the ability to write checks, issuers limit withdrawals based on federal regulations. These accounts are not meant for everyday spending, but they can provide cash liquidity when needed.
Consider Investing in the Money Market
The money market may provide an opportunity to earn a greater return on your cash than you’d earn from a standard savings account while still affording you the liquidity you need to meet cash needs. As with any investment decision, consider consulting with a financial advisor before taking action. An advisor can help you assess your needs and identify a suitable allocation between money markets and other investments.
Reach out to a financial advisor today to learn more about the money market or make adjustments to your investment strategy.