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Money market funds and short-term bonds have many
similarities, but they also differ in several ways. They're both excellent
savings vehicles on a short-term basis. Both are liquid, easily accessible, and
relatively safe securities. But these investments can involve fees and they may
lose value and decrease an investor's purchasing power.
The money market is part of the fixed-income market that
specializes in short-term debt securities that mature in less than one year.
Most money market investments mature in three months or less. These are
considered to be cash investments because of their quick maturity dates.
Money market securities are issued by governments, financial
institutions, and large corporations as promises to repay debts. They're
considered extremely safe and conservative, especially during volatile times.
Access to the money market is typically obtained through money market mutual
funds or a money market bank account in which thousands of investors are pooled
to buy money market securities on the investors’ behalf.
Shares can be bought or sold as desired, often through
check-writing privileges. A minimum balance is typically required and a limited
number of monthly transactions are allowed. The net asset value (NAV) typically
stays around $1 per share, so only the yield fluctuates
Purchasing power is limited, especially when inflation
increases. A penalty may be assessed if an account drops below a minimum
balance or if the number of monthly transactions is exceeded. Fees can take
away much of the profit with such limited returns.
Shares are not
guaranteed by the Federal Deposit Insurance Corporation (FDIC), the National
Credit Union Administration (NCUA), or by any other agency unless an account is
opened at a bank or credit union.
Bonds have much in common with money market securities. A
bond is issued by a government or corporation as a promise to pay back money
borrowed to finance specific projects and activities. More money is necessary
than the average bank can provide in such cases, which is why organizations turn
to the public for assistance.
Buying a bond effectively means giving the issuer a loan for
a set duration. The issuer pays a predetermined interest rate at set intervals
until the bond matures. The issuer then pays back the bond’s face value at
maturity. A higher interest rate generally means a higher risk of complete repayment
with interest.
Short-term bonds can be relatively predictable, low-risk
income. Stronger returns can be realized when compared to money markets. Some
bonds even come tax-free.
A short-term bond offers a higher potential yield than money
market funds. Bonds with quicker maturity rates are also typically less
sensitive to increasing or decreasing interest rates than other
securities. Buying and holding a bond until its due means receiving the
principal and interest according to the stated rate.
Funds that hold a high concentration of government
securities are considered by many to be the safest, particularly if they hold
Treasuries, which are backed by the government and therefore carry a lesser
risk of default.5
What's the Difference Between a Short-Term and a Long-Term
Bond?
A short-term bond will typically mature within no more than
three years. A long-term bond may not mature until after 10 years. The bond's
"coupon" or interest should be paid out a few times a year in either
case. Deciding between them can depend on your goals and whether you're
investing for the long-term or to achieve something that's on a closer horizon.6
Which Is Safer, a Bond or a Money Market Fund?
Bonds carry more risk than money market funds. A bond's
lender may not be able to make interest or principal payments on time, or the
bond may be paid off early with the remaining interest payments lost. The bond
may be called, paid off, and reissued at a lower rate if interest rates go
down, resulting in lost income for the bond owner.7
There are both pros and cons to investing in money market
funds and short-term bonds.
Money market accounts are excellent for emergency
funds because account values typically remain stable or slightly increase
in value. Limited transactions discourage removing funds but the money is
nonetheless available when it's needed. Short-term bonds typically yield higher
interest rates than money market funds, so the potential to earn more income
over time is greater.
Overall, short-term bonds appear to be a better investment
than money market funds.
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