Money Markets

Money Markets Vs Fixed-Income: What’s the Difference?

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Money Markets Vs Fixed-Income, the topics you will learn are:

  • Difference between Fixed Income and Money Market
  • Money Market Advantage
  • Money Market product examples
  • How Money Market products work

Difference between Money Market and Fixed Income

difference between money market and bond market

Fixed income is a type of investment instrument that pays investors fixed interest payments until the maturity date. At maturity, investors will be paid back the principal amount they have invested.

Meanwhile, the money market is a type of short-term fixed-income investment. Money markets tend to have high levels of security and liquidity, as well as relatively lower interest rates.

Also Read: 7 Secrets of How to Invest Safely for Beginners

Understanding Money Market

Fixed-income assets have maturities ranging from one night to a maximum of one year. Money market funds are low risk and liquid (can be converted into cash at any time). An example is time deposits in financial institutions.

Some are accessible through retail locations such as banks. However, retail investors tend to earn lower interest rates compared to wholesale transactions for large-denomination institutional clients.

Different Types of Money Market Instruments

Money market funds

A mutual fund that invests in money market instruments and provides retail investors with diversification and access to higher interest rates.

Money market account

A type of savings account that limits the frequency with which money is withdrawn. Due to the limited access of investors to these deposits, these products tend to offer slightly higher interest rates than standard savings accounts.

Term Deposit (Certificate of Deposit)

Some time deposits can be as short as 2 days (Deposits on Call). The interest rate offered remains constant for the period of deposit, but there may be a penalty associated with the early withdrawal of funds held in the Certificate of Deposit.

Commercial paper

It is an unsecured short-term loan for corporations.

Also Read: 4 Types of Low-Risk Investment that is not known to many people

Money Market Advantages:

  • Stable income stream
  • Returns are more stable than stocks
  • Higher claims for assets when there is bankruptcy
  • Some funds have government support (Deposit Insurance Agency)

Money Market Disadvantages:

  • Yield is lower than equity
  • Vulnerable to inflation risk
  • No capital appreciation or upgrade

How does it work?

Example:

The investment manager will choose 5 money market instruments to set up a money market mutual fund. The investment manager allocates 30% of the portfolio to Commercial Bonds B because of the high rate of return, but no more because he wants to limit risk.

When an investor puts $10 into this fund, it is equivalent to investing $3 in Commercial Bond B, $2.5 in Deposit A, and the rest in other instruments according to the portfolio allocation shown in the diagram.

what is money market

Each money market instrument will generate a different return, ranging from 5% to 9%. As mentioned in other tutorials, higher returns tend to come with higher risks. The reason why 100% of funds have not been allocated to 9% instruments is that it is likely to have the highest risk so the exposure is limited.

Because the portfolio allocation is managed and monitored by the investment manager, the return that investors will get is the average return of all instruments in the portfolio. The goal is that the yield is better than the average return on deposits in the bank.

Also Read: 6 High-risk Investment Mistakes according to Warren Buffett

Is it clear with the meaning of the money market? One of the keys to investing is diversification, so maybe you have thought about dividing your investment into certain asset classes including money markets.

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