Investing In Money Market Accounts
For CDs, in exchange for lending the institution cash for a predetermined length of time
, the investor is paid a set rate of interest. Maturities on certificates of deposit can range from only a few weeks to several years with the interest rate earned by the investor increasing in proportion to the time his capital is tied up in the investment.
Money markets, on the other hand, offer many of the same benefits as certificates of deposit with the added features of a checking account. Technically speaking, this account is more or less a mutual trust that attempts to keep its share price at a constant $1.
Professional finance managers will take the reserves deposited in the money market and invest them in government t-bills, savings bonds, certificates of deposit, and other safe and conservative financial instruments. This income is then paid out to the owners of the account.
Investors can open this kind of account at most financial institutions. They generally receive a checkbook with which they can draw upon funds in the account.
If you imagine that people buy and sell stocks, then you can see how people buy and sell cash in the money markets. The process of buying and selling cash means that you borrow or loan funds, respectively.
Similar to your deposit accounts at the bank, money market reserves take your capital and invest it. Then, they pay a portion of their earnings to you in the form of dividends.
Your funds usually pay a monthly dividend, but there are some alternatives out there. These funds invest in short term instruments that mature in less than 13 months - at a maximum.
By keeping a short time-frame, these trusts attempt to reduce risk. In fact, the SEC says that the average maturity of all the investments in this kind of fund must be less than 90 days.
The longer you loan cash to somebody, the greater the chance that something will happen and they won't be able to pay you back. Typical investments inside a money market fund might be US Treasury issues, short-term corporate paper, and CD's.
There are at least three risks that come with investing in an account. First, a money market fund is technically a security.
The fund managers attempt to keep the share price constant at $1/share, but there is no guarantee that the share price will stay at $1/share. If the share price goes down, you can lose some or all of your principal.
In return for this risk, you should earn a greater return on your cash than you'd expect from an FDIC insured savings account. Note also that these types of trusts are not FDIC insured.
Next, money market account rates are variable, which means you don't know how much you'll earn on your investment next month. The rate could go up or down.
If it goes up, that may be a good thing, but if it goes down and you earn less than you expected, you can end up needing more cash. A final risk you're taking with these types of accounts has to do with inflation.
Because they are considered to be safer than other investments like stocks, long term average returns on these funds tends to be less than long term average returns on riskier investments. Over long periods of time, inflation can eat away at your returns.
Investors who want a decent return from a relatively safe investment use money market accounts. The investments are typically liquid, meaning you can usually get your cash out within a few business days.
You can also take advantage of rising interest rates by keeping your capital in an investment that will adjust to the economy. A lot of institutions allow you to write checks that draw from a money market fund.
Therefore, you get the advantages of dividend earnings as well as easy access to your cash. Make sure you ask what restrictions or fees your institution has.
by: Terry Daniels
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