What You Should Know About Money Market Funds & Accounts

The essential beginners guide to investing in money markets either by funds or accounts

In today’s economy, the world of finance can be an incredibly complex and often confusing one, especially for the novice investor. There exist a wide variety of different ways to invest your money, with new options being devised by financial companies on a frequent basis. This highlights the importance of making an informed choice when it comes to making financial decisions both large and small.

One of the most fundamental financial decisions that almost everyone is faced with is where to put their money so that it grows at an effective rate. For many the stock market is a logical choice, as the many listings to choose from offer different advantages and can provide substantial returns. However, in a bear market (such as the one currently being experienced internationally), the safety of investing money in stocks and shares can diminish considerably as the risks associated with unpredictable trends and fluctuations increase. These risks can often scare off investors and force them to look for a safer place to invest their funds.

The money market offers an interesting investment option that is generally safer and more predictable than the stock market. While this market is generally used more by governmental and larger corporate institutions, it is also accessible to individual investors via a number of routes. Before examining what these are, it’s important to come to an understanding of just what the money market (sometimes also known as the cash market) entails.

piggy bank

What is the money market?

Simply put, the money market constitutes a subsection of the fixed income market. While the most commonly known type of fixed income security is the bond, the money market is a similar type of investment opportunity that focuses on short-term debt securities (most of which mature in under a year).

Securities traded on the money market can be issued to individual investors by the government, large corporations, or other financial institutions as a highly secure form of a liquid asset – in simple terms, an ‘IOU’. By dealing with such financially secure entities, the reliability of trading on the money market is a significant drawing card for many investors. The tradeoff, however, is that money market securities generally offer relatively low (if dependable) returns than other types.

Differences between the stock and money markets

Apart from the returns, another difference between the money market and the stock market lies in the value of the denominations traded. Generally speaking, the money market deals only in high denominations, which can limit its accessibility to individual investors (also explaining why it is predominantly the domain of larger financial entities).

The money market is also classified as a dealer market, meaning that transactions are conducted directly within various firms’ accounts, without the need for a central trading floor (such as a stock exchange) or brokers. This cutting out of the middleman means that deals can be negotiated more directly (such as over the phone or electronically).

How to invest in the money market

Perhaps the simplest and most common way for individual investors to access the money market is through money market mutual funds or a money market bank account. These funds are generally offered by banks or other financial institutions, and work by pooling the funds of many investors and using them to purchase money market securities on their behalf.

Some large corporations with preexisting access to the money market may also offer investors the opportunity to acquire money market assets by proxy. Some banks may also offer packages whereby the bank chooses the best investment for your money from a list of high-performing funds.

In practice, most money market accounts work much like normal savings accounts. As a money market account holder, the money you deposit into this account is used by the bank to fund loans to other people. In return, the bank pays you interest on the amount deposited. By charging a slightly higher interest rate on these loans than the one paid to you on your deposit, the bank is able to continue turning over a profit.

Interest on money market accounts is generally compounded and paid out on a monthly basis. As with other forms of compound interest, this provides the distinct advantage to the investor of the bank paying you interest not only on your initial deposit, but also on the accumulated interest the bank regularly pays out. Of course, in the competitive financial market, interest rates on money market accounts can vary considerably. Some banks may also offer different interest rates depending on the amount of money currently invested in the account. As such, it’s best to explore and compare many options before deciding on the account that is best for you.

 

The less money you owe, the less income you'll need and the less you'll have to save for tomorrow.

Suze Orman

Like savings accounts, money market accounts allow you to withdraw money from your account on demand. However, in order to maintain the level of security for which the money market is known, many banks only allow you a limited number of withdrawals per month (some may allow additional withdrawals, but include a surcharge on any that exceed the predetermined limit). Many may also enforce a minimum balance that needs to be maintained in the account itself.

Upon opening a money market accounts, most banks will provide you with a register book to keep track of your initial and subsequent deposits, withdrawals, and the amount of interest earned on your money. The bank will also send you a monthly statement that will list all your transactions as well as fees and interest earned. By reconciling these two financial records, you can take better control of your own money management.

In Summary

As with many types of bank accounts, arguably the best way to maximise returns on your money market account is to make regular deposits. By doing so, the amount on which you earn interest (and therefore the interest itself) will steadily increase. Even small deposits, if made regularly, can add up to significant increases in compound interest over the years.

All in all, the money market is a great option for both novice and experienced investors, and is one of the most reliable and risk-free ways to watch your money grow.