If you’re an investor you’ve probably come across the term "money market" many times. However, many don’t use this investing vehicle because they don’t understand how it works or assume it's only used by big corporations and governments.
With the emergence of money market funds, though, every investor can now participate in the money market. It can be a great place to invest your money for a short period of time before you make a long-term investment decision. The return is slightly better than your bank savings or chequing account and is also considered one of the safest most conservative places to park your cash.
What is the money market?
A money market is a subsection of the financial markets, and a place for financial institutions to borrow or lend for a short period, generally less than one year. The money market consists of securities like government bonds, commercial paper, short-term mortgages and asset backed-securities. These are some of the safest places to invest money for the short-term, but they also have very low returns compared to stocks and bonds. Money market transactions are usually wholesale and in very large quantities.
How are they used by investors?
Generally, government bodies, financial institutions and large corporations use these markets to transfer large sums of money. For example, governments can use them to raise money, set monetary policy and short-term interest rates. Big corporations can use the money market to lend funds to other big corporations or borrow at ultra low rates for a short period of time. Money and liquidity is the commodity in the “money” market.
Why is this type of investing necessary?
For large short-term transactions to take place, there needs to be a money market to make it happen. This is not a place to get rich or invest for the long term. For example on June 28th, 2013, the money market was yielding 1.01%, barely above what a commercial bank will give you to keep your money in a savings account. But they are considered safe.
How can individual investors benefit?
For retail investors who have just sold a large portion of their RRSP or TFSA and the amount is sitting in cash, money market funds are a good place to park the cash to give you some interest while you make up your mind on what to buy next.
They are fixed interest products, meaning no surprises for the potential payout, no matter how small. Money markets can make up an important part of you portfolio.
Often, when a financial advisor says you should keep some of your money in cash, they are referring to a money market fund. Talk you financial institution or your online brokerage about the money market funds that are available to you and let your money make money for you while you pause to make a bigger longer-term investment decision.