The Advantages, Disadvantages and Varieties of a Low-Risk Investment Vehicle
Having a method that’s open-ended, money market funds invest in short-term debt securities. Offered by many brokerages, they are also an important source of liquidity to the economy. For your personal economy, however, they offer a relatively low-risk investment that will tend to pay higher interest than a savings account would. They are required by law to invest in highly rated debt with short maturities. This debt can be government bonds, corporate bonds, or some combination of the two.
While money market funds are safer than other mutual funds which may be invested in such volatile areas as the stock market, this does not mean that losses are unheard of. Recent failures of large financial institutions have caused a minor panic, and money fled from corporate debt to the perceived safety of government debt. This lowered the value of corporate bonds, increasing the yield needed to sell new issues, while the yields on the in-demand government bonds, particularly U.S. Treasury bills, have at times plummeted to near-zero. Recent events such as the bankruptcy of the city of Vallejo, California, and the well-reported difficulties economic difficulties of the states, widened the yield spread between federal government bonds and the government bonds of states and municipalities.
On a positive note, these changes now offer a wider range of possibilities in terms of risk and return than was present before in money market funds. An investor could at one time put all their money into Treasury bills for what is perceived to be almost zero-risk, but also near-zero interest. In times when inflation is active, such low yields can actually result in a negative real return! However, with the markets so unsettled, in recent times some Treasury bills have had to offer higher yields than even private bonds to attract enough demand.
Bonds and You
Greater returns can be gained with state and municipal bonds, and at one time municipal bonds were seen as an excellent, safe place to put one’s money. Government bonds frequently feature tax advantages, such as the exemption of interest income from state and federal taxation, which effectively gives them a tremendous advantage over private debt. However, because of the previously noted financial scares in state and local governments, state and municipal bonds are now seen as being much riskier than they once were.
Private-issued bonds are traditionally seen as the riskiest and highest-yielding bonds. Not only do companies go bankrupt or otherwise default far more often than governments, but they do not enjoy the tax advantages of government bonds. However, recently some private debt has been sold at lower rates than Treasury bills of the same term, in large part because of the huge amounts of debt the federal government has created to fund various programs for mitigation of the current economic crisis. Similar effects have been seen in some municipal and state bond offerings.
The Money Market Account
Another alternative that should be looked into by investors is known as a money market account (as opposed to money market fund). They are offered by banks as opposed to brokerages, and in their inner workings are not truly related. However, these deposit accounts are created specifically to compete with the money market funds, offering similar interest rates and terms. Like a money market fund, they tend to have a higher interest rate than savings accounts but allow limited check writing and have relatively high minimum balances. While they are not tax-advantaged, they do have the distinct advantage of being FDIC-insured like most bank accounts. Meaning that you are probably no more likely to lose your money than an investor in Treasury bills; a possibility that even the most pessimistic forecaster sees as remote, at least in the near-term.
As an individual investor, many factors will need to be taken into account when selecting a money market fund. There are different fees each brokerage may charge for investment with them, which can render even a higher-yielding fund less profitable. Debt issued by various governments has historically been lower-risk and lower-yield than corporate debts, which along with their tax advantages have made them very attractive for the conservative investor. Unfortunately, in these troubling times, old expectations of more secured growth have slowly become irrelevant. In money markets, or any investment, it pays to tread carefully. It still stands that bond-holders tend to get top priority among the obligations of the various bodies that issue such debt and money market funds must, with the exception of funds dedicated to Treasury bills and similar large government issues, maintain a well-diversified portfolio. As such, investing in a money market fund remains a safer alternative than investing in equities or commodities.
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