Money market vs. Capital market: what’s the difference?
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There are two ways to manage wealth: maintain what you have or grow it.
Which path to choose can be confusing. And recently, investors are nervous about rising inflation reports.
Where to invest your money comes down to two components of the financial market: Money Market or the capital market.
the Money Market and the capital market are two major 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“Applies to high-quality short-term debt securities that mature within one year,” says Robert johnson, professor of finance at Heider College of Business, 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 T-Bill and essentially act as a lender to the US government. The Treasury will reimburse 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 certain time to earn interest.
- Commercial paper, which is essentially a corporate IOU. The company issues a note not backed by a guarantee that it undertakes 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 maturation periods greater than one year. This includes stocks and bonds.
Key differences: the money market versus the money market. 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 preserve the money they have, even if they generate only a modest return on investment.
The short-term investor needs money in the short term – within a year. While this is often referred to in terms of how close you are to retirement age, there are other reasons you might need the money soon, says Riley Adams, CPA, senior financial analyst for Google and owner of the. personal finance blog the Young and committed. Maybe you’re saving for a new car, a new house, or a new college. Whenever you need cash quickly, your number one priority is to preserve it – preferring the safety of the 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 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 money market 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,” Johnson says. For investors with a long time horizon, such as saving in their twenties for retirement, 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, it is better to put it Money Market because of that 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 will soon need this money will be motivated to preserve wealth rather than accumulate 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 fall into the correction and that you can no longer 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 suffer sleepless nights when the market falls into a correction, ”Johnson says. 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 to capital investmentAdams explains. However, the time will come when you have to transfer that money capital market investments for Money Market investments. “When you approach any major purchasing decision requiring the cash you have on hand, you want to plan for a transition. 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. Hidden in the middle is the statistical fact that there are good and bad years. Investors with long-term horizons can usually take advantage of those exceptional years when stocks rise more than 10% to compensate for years when they fall below.