What are Money Markets and CDs?

Sources: Bankrate.com, Experian.com

Money Markets are short-term debt securities with maturities of one year or less that are traded. They are good for short-term financing and investing with safety, liquidity and modest returns.

They help the government, corporations, and banks (financial institutions) manage short-term liquidity and invest surplus cash safely and efficiently.

Quick Summary of the Pros & Cons

Pros:

• Liquidity: Quick conversion to cash.

• Low risk as long as the value per share doesn’t go below $1.

• Instruments traded are: US treasury bills issued by the government (considered safest), commercial paper (unsecured promissory notes [i.e. I owe you]from highly credit worthy corporations), certificates of deposit (CDs) and repurchase agreements (Repos). Repos are short-term loans collateralized by securities often used overnight.

• Wholesale trading: transactions usually happen over the counter between large institutions although retail investors can access them via money market funds/accounts.

Cons:

• No FDIC Federal Protection

• Market Fund Fees could increase

• No Protection against inflation if inflation goes beyond your return for your money market.

Who Uses Money Markets?

1. Borrowers like governments to fund public debt, corporations for working capital and banks (to meet the reserve requirements.)

2. Lenders like institutional investors, money market funds, and individuals seeking safe liquid investments.

What is a Money Market Fund (MMF)?

These are mutual funds investing in short-term debt securities. The goal is to maintain a stable net asset value of $1 per share but they are NOT FDIC insured. They can also protect your capital (bank balance) from inflation as long as the value of the MMF doesn’t go below $1 per share. The returns are usually modest but they fluctuate and the risk is minimal.

What is a Money Market Account (MMA)?

These accounts are a hybrid account between savings accounts and checking accounts. They are offered by banks and credit unions. They pay you a higher earning interest rate compared to a traditional bank savings account but they aren’t always as high as a high yield savings account. They are FDIC insured up to $250,000 and may have withdrawal limits and minimum balance requirements. They are flexible like a checking account and come with a debit card. The liquidity (i.e. your ability to access your money) is a plus compared to a high yield savings account.

Money Markets support policy implementation and help stabilize financial systems. They are ideal for managing cash flow and preserving capital. There is a credit risk with Commercial Papers, an interest rate risk and a potential for loss if the fund drops below $1 per share. It’s rare but the last time this happened was 2008.

What is a Certificate of Deposit (CD)?

These are time deposits offered by banks often with terms ranging from a few months to a year. You deposit money into your certificate for a certain amount of time while earning interest towards your goals. For example, if you are saving up for a wedding you can open a certificate of deposit, make monthly deposits and earn interest. When the term of your certificate is finished (i.e. It has matured), you can either withdraw all your money plus the interest or renew/roll-over the certificate to a current interest rate.

There are early withdrawal penalties if you withdraw money before the date you initially asked for. If you would like to save for multiple events in the future, the term for that is called CD laddering. This just means many CDs will mature at different dates. Depending on your total income for the year, you will have to claim your interest earnings on your taxes.

*Extra Definitions: Eurodollars - US dollar denominated deposits held in foreign banks.

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