Thursday, October 19

Overview of Investment Product: Cash & Money Markets

I guess everyone knows what cash is. Cash can also be seen as the safest type of investment product: it gives return in the form of interest income.

However, on a historical basis, interest income barely beats inflation. Therefore, a smart investor will look for alternatives.

Here comes the money market funds.

What is it?

It is a type of mutual funds that invest in USD denominated, high-quality, short-term (90 days or less) debt instruments issued by the US government, municipalities, banks and big corporations. Similar to other mutual funds, money market funds can be traded once a day.

Because money market investments are considered less volatile than individual stocks or stock funds, investors can adjust their portfolio's volatility by including a portion of money market funds. They can also "park" their money here in between investments.

As a low-risk investment product, how does it compare to cash/CDs?

PROS
  • Higher return: the yield is competitive with (if not slightly better than) many savings accounts and is more liquid than bank CDs.
  • Tax benefits: For US citizens and residents, municipal money market funds can provide state and federal tax-free income, which can be beneficial for those in higher tax brackets.

CONS
  • Fluctuating yields: Short-term yields have been much more volatile than long-term rates over time, while interest income from a bank gives you a more stable return.

I don't want to bear much risk. Should I invest fully in money markets?

Yes, but without any higher-risk investment products your portfolio's return may not keep up with inflation. That is, your money will worth less than today, and you will be worse off.

Therefore, most investment advisors suggest inclusion of different investment products. We are going to talk about them in the next session.

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