5 Investment Instruments Of Money Market.
Investment instruments get their name because of their higher capacity for liquidity, making these almost the equivalent of cash as far as a financial transaction. Compared to capital market instruments such as bonds and stocks, they offer more security and a decreased likelihood of defaulting although at a lower rate of return.
Because they aren’t FDIC insured, they also carry with them no insurance of compensation in the event of default. The good news is because money market instruments are typically dealt with via funds, banks, and high-credit lenders, they are considered very stable instruments.
For those looking to diversify their portfolio and earn some interest on short-term investment instruments, there are 5 money market instruments you must know in order to get the most bang for your buck.
Money Market Funds
A money market fund is essentially a mutual fund that invests in short-term, high-quality debt such as US treasuries. Money market funds are highly regarded because they offer high liquidity and low risk relative to returns. Unlike a certificate of deposit, for example, there is no time to maturity for the initial investment; you can withdraw from the account whenever you choose.
Money market funds also offer the possibility of investing in short-term corporate or bank securities, government securities, or municipal bonds, with the latter option offering tax-free yields. The yields for a money market fund are much more responsive to market interest rates, which can be more favorable than a money market account when rates suddenly increase, allowing the account to accrue more interest faster.
When choosing a money market fund, choosing a fund that doesn’t require a high initial investment allows greater accessibility as well as lower costs to manage the fund. Although historically low-interest rates don’t always incentivize investing in a money market fund, for those hoping to earn some interest on cash, doing so allows for potentially higher returns on the investment without sacrificing the liquidity of a savings account.
Money Market Accounts
A money market account slightly differs from a money market fund in certain capacities, providing advantages and disadvantages for those interested in money market investments. First, money market accounts are offered through financial institutions such as banks and therefore offer FDIC insurance for the principal invested, unlike money market funds.
Second, a money market account can provide limited check-writing and withdrawal privileges, though this is dependent on the institution. Money market accounts are therefore somewhat similar to high-yield savings accounts. When choosing a money market account, avoid accounts that require high minimum balances and monthly fees, as this will limit your initial investment and may offset any interest earned.
Likewise, it’s important to evaluate the interest rates as some money market accounts are less advantageous than investing in a high-yield savings account while presenting more restrictions on the liquidity of your investment. In short, a money market account is a good alternative for someone who can find a slightly higher rate than what is offered in a savings account while also providing limited purchasing accessibility.
Certificates of Deposit
A certificate of deposit, or cd, is another financial instrument that offers slightly more return without compromising security but with slightly less liquidity.
The premise of a cd is that the account holder purchases a cd at a certain principal investment, for example, $100, and at the end of the term of the certificate of deposit, the cd holder has the option of renewing the cd for a similar term or terminating the certificate.
Completing the certificate results in earning the maximum interest accruable relative to the term of the certificate; most financial institutions offer a fixed interest rate at the beginning of the term of the cd, while some may offer a flexible interest rate (which may or may not be desirable in the event that interest rates decrease during the term of the cd).
The limitation of purchasing a cd is that your money is relatively illiquid during the term of the cd. Withdrawing any or all of your principal from the cd often results in a withdrawal penalty that can offset any interest accrued.
The benefit of a cd is that you generally earn higher interest rates than with a savings account or money market account, your principal is FDIC insured and, for those who aren’t as disciplined and may risk overdrawing on their savings or money market accounts, it deters withdrawal during the duration of the cd.
When shopping around for CDs, online and local banks can offer substantially higher rates than national banks for CDs with similar terms.
Commercial paper investments are typically accessed through a money market fund, however, they offer a divergent investment strategy for those looking to diversify their money market options. Commercial paper investments are issued by high-credit corporations looking to meet capital needs. Commercial paper investments include promissory notes, drafts, and corporate checks.
The advantages of investing in commercial paper include the short time frames for the investments (1-270 days) that retain liquidity while earning interest. The disadvantage is that it is not FDIC insured and because of the high volume that commercial paper is sold (typically purchased in $100,000 increments) it is only available through commercial investors or a money market fund.
To simplify a complicated transaction, a banker’s acceptance is simply a financial instrument issued from a lending institution with a guaranteed transfer of funds at a later date. Because the date is postmarked after issuance, funds can’t be transferred in the meantime.
That being said, the instrument does guarantee the transfer of funds, which allows it to be used as a financial instrument where the recipient of the funds can sell the banker’s acceptance to investors who will then be paid at the later date. Given that banker’s acceptances are issued by reputable lending institutions, there is high security relative to the instrument itself as well as the assurance from the seller who was issued the acceptance.
Bankers’ acceptances are not high-yielding instruments, generally offering slightly higher rates than treasury bills, however, they are relatively liquid and offer another investment opportunity through a money market fund. Ultimately, for those looking for relatively high security, highly liquid options to earn some interest on cash, money market instruments offer a plethora of possibilities to add some extra change to your hard-earned dollars.