Money market vs. Capital market: what’s the difference?
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There are two ways to manage your wealth: keep what you own or make it grow.
Which path to choose can be confusing. And recently, investors are nervous about reports of rising inflation.
Where to invest your money comes down to two components of the financial market: the Money Market or the capital market.
the Money Market and the capital market are two important components of the global financial market where invested funds are used for short or long term borrowing and lending.
Here are the main differences between them and tips to help you find where to invest.
Money market overview
“The term ‘Money Market‘is applied to high-quality short-term debt instruments that mature within one year, ”says Robert Johnson, professor of finance at Heider College of Business at Creighton University and co-author of“ Investment Banking for Dummies ”. They are known to have a low yield but are considered safe.
If you need money within a year for a planned expense, like a down payment on a house, keep it in the money market.
These debt securities include:
- US Treasury Bills, sometimes referred to as T-Bills, is short-term debt issued by the US Treasury. The public can buy a treasury bill and essentially act as a lender to the US government. The Treasury reimburses the purchaser on a determined due date with interest.
- Certificates of depositt, offered by banks and brokerage firms where you can deposit funds for a period of time to earn interest.
- Commercial paper, which is essentially a corporate IOU. The company issues a non-collateralized note, which it agrees to repay on the due date with interest.
Capital market overview
the capital market is a way to accumulate value over time with longer-term assets with maturing periods beyond one year. This includes stocks and bonds.
Key differences: money market vs. Capital market
The money market and the capital market work differently and tend to attract different types of investors.
The investor is risk averse worries about losing money. This investor will feel more comfortable using the Money Market because they will keep the money they have, even if they generate only a modest return on their investment.
The short-term investor needs money in the short term – within a year. While this is often referred to in terms of proximity to retirement age, there are other reasons you might need the cash soon, says Riley Adams, CPA, senior financial analyst for Google and blog owner. of The Young and the Invested Personal Finance. Maybe you’re saving for a new car, a new house, or a new college. Whenever you need money fast, your number one priority is to preserve it – preferring the safety of the money. Money Market.
The risk-tolerant investor understands that risk is the price you pay for the potential for a great reward and looks for the potential for greater profit offered by the capital market.
The long-term investor has a long-term horizon, so that they can invest in the capital market. If stocks fall, these long-term investors will generally be able to recoup their losses over time.
Comparison of money market and capital market
From an investor’s point of view, “the main difference is the Money Market is short term, very safe and very liquid, ”says Adams. By comparing the Money Market and the capital market step by step can help you understand why the money markett may be the preferred choice for a short term investment need and how it differs from a capital market investment like buying stocks.
This graph can help you conceptualize the formats, advantages and disadvantages of these two financial markets.
|Point of comparison||Money Market||Capital market|
|Examples||Certificates of deposit (CDs), treasury bills, commercial paper||Stocks and Bonds|
|Duration||Short term (1 year or less)||Long term (over 1 year)|
|Investment objective||Maintain wealth||Generate wealth|
|Level of volatility||Low||High|
What is the best investment?
The best place to invest “depends on your goal and your time horizon,” says Johnson. For investors with a long-term horizon, such as retirement savings in their twenties, the capital market is the best choice. A large-cap index fund is a good start for these investors, recommends Johnson.
“If you need this money in a year or two, you better put it in the Money Market because of this volatility, ”Johnson recommends. the Money Market is a lower risk. “People who invest in Money Market can sleep well. There is very little volatility but very little growth, ”says Johnson.
Those who need money soon will be motivated to preserve wealth rather than accumulating it. You wouldn’t put the money you saved for a down payment on the stock market (capital market) because there is a chance that it will go into correction and you will no longer be able to afford the house of your dreams. With a Money Market investment, your down payment wouldn’t go up much – but it wouldn’t evaporate due to market volatility, so you can count on it to be there when you prepare to make that offer.
Conversely, “those capital market investors can have sleepless nights when the market enters a correction, ”Johnson said. Despite the risk, those who invest in the capital market may be better rewarded than the money market if they wait.
“If you are looking for a long-term retirement, like retirement, you want it to be in a capital investmentAdams explains. However, the time will come when you will need to transfer that money from capital market investments at Money Market investments. “As you approach a major buying decision where you need the money you have, you want to plan for a transition from capital market at Money Market because it ensures that your money will be there, ”Adams says.
Since 1926, the S&P 500 – a capital market – grew by 10.3% per year, says Johnson. In the mean is the statistical fact that there are good and bad years. Investors with long-term horizons can usually take advantage of peak years when stocks rise more than 10% to compensate for years when they fall below.