Why investing in the money market makes sense
Over the last few years a lot of people have become very nervous about investing their money. The reason of course is that they got burned badly in the stock market. This is why it is important to have some of your money invested in other places where there isn't so much risk involved. The money market is one of the best places to keep your money safe.
The main reason why it makes sense to invest in the money market is that it is a safe place to keep your money. The money market consists of short term debt, usually of the highest quality. The reason that this can keep your money safe is that since the debt has only a short time to maturity the risks of default are very low. In addition there is also a very low risk of interest rates changing by a large enough amount to have a serious impact on the returns you get from the money market.
The first thing that you need to know if you are thinking about investing in the money market is just what kind of things are traded. This would include Treasury bills, commercial paper, short term mortgages, certificates of deposit and even cash. What they all have in common is that they are high quality loans with a low risk of non-payment and they all have less then one year until maturity. The reason that it is important that they have only a short time to maturity is that it makes sure that you are not exposed to nearly the same level of interest rate risk that you would be if you invested in something longer term.
The other key feature that the money market has is that it is highly liquid, in fact the whole point of the money market is to ensure that there is enough liquidity to keep the economy moving. This is important because it means that you can turn your investment into cash easily at any time that you need to. This is important for a few reasons, first that you may find that you actually have a need for the cash. The other reason is that it reduces the risk that you may not be able to get out of your position. With other investments there is a risk that if the market turns against you might not be able to find a buyer allowing you to get out of your position, this is called liquidity risk. This is very low in the money market because it was created for the specific purpose of ensuring liquidity.
Since we have decided that the money market is as good place to invest your money the question has to be asked of just how do you go about doing it. There are several options available, one is that you could just go to the bank and buy a certificate of deposit. The problem is that this is a somewhat limited investment option and doesn't really give you most of the benefits that investing in the money market is supposed to provide. The other option is to buy Treasury bills, commercial paper or mortgages yourself. The problem here is that most people have no idea how to do this and even if they did would find that they were exposing themselves to more risk than they realized because they couldn't afford to buy enough to properly diversify. Clearly another approach is necessary if you are going to invest in the money market.
The best way to invest in the money market is through a money market fund. This is similar to a mutual fund except that the money is invested in short term securities. There are a few reasons that a fund is a better option for most investors, the biggest is making sure that they are able to get enough diversity. There are a lot of investment options when it comes to the money market and you need to make sure that you are in enough of them to keep you safe if one investment does turn a against you. The other issue that you have when you invest in the money market is that since the things that you are investing in have only a short time to maturity they are constantly having to be replaced by new investments. That means that you have to be very active in managing your investments, something that most people have neither the skills nor the time to do. With a money market fund the manager will take care of that for you.
While a money market fund is similar to a mutual fund there is an important difference to keep in mind if you are going to invest in one. The difference is that the goal of a money market fund is to retain its value. With most mutual funds the idea is that the value of the fund should increase, this is not the case with a money market fund which is intended to remain steady. Instead what the money market fund does is keeps its value steady and pays a dividend to the investor. This of course offers another advantage since you are getting cash at regular intervals rather than having your money tied up in your investment like you would if you bought a mutual fund. Make no mistake there is a risk that the value of the fund could decline however that is quite rare.
Because a money market fund pays a regular dividend and doesn't increase in value a lot of people confuse them with an annuity. The difference is that with an annuity you invest your money and you receive your payments but you don't get the original amount back. In the case of a money market fund you can sell it at any time that you want and get your original investment back.