With the exception of their maturity dates, bonds and money market securities are similar products. These assets provide opportunities for you to preserve purchasing power on cash through interest earnings. Over the long term, money market and bond investments exhibit much less volatility than stocks. In exchange for safety of principal, you should be willing to accept relatively small returns on bonds and money market securities.
Money market securities are separate from money market deposit accounts. Money market securities are not guaranteed. Money market deposit accounts offered by banks, however, are backed by FDIC guarantees. As of 2010, the FDIC insures $250,000 worth of your deposits at each bank that you patronize. Banks are not obligated to invest your money market deposits into money market securities.
Bonds and money market investments are credit securities. As an investor, you are actually loaning out money to a corporate or government entity. In exchange for your loan principal, you collect interest payments until maturity.
Within a corporation, credit securities feature senior asset claims above equities, or stocks. Amid corporate bankruptcy, money market and bond investors are to be paid first from the proceeds of any asset liquidations. Because of these terms, credit securities are less risky than stocks.
Money market assets mature in less than one year. Because of their maturity dates, money market assets are less risky than bonds. Again, lower risks translate into lower returns for money market assets. In terms of default risks, a corporation is less likely to go bankrupt over three months than it is to fail and miss interest payments in three years.
Interest rate risks refer to shifts within prevailing interest rates that adversely affect your returns. Existing credit securities lose value when interest rates move higher. For example, you may purchase a 30-year bond from Corporation X that carries a 5 percent interest rate. Next year, this 30-year bond would lose significant value if Corporation X then issues new 30-year bonds that pay out 7 percent interest rates.
Money market securities are much less volatile than long-term bonds, because you are not locked into a set interest rate for an extensive time period. Within the next year, the money market asset will mature and you can reinvest your money into new assets that pay higher rates.
Money market securities are more so ideal for cash management purposes. For example, you may put cash into a money market fund while you save for a home down payment. In addition to intermediate-term savings goals, money market assets can also provide cash amid emergency situations. Bonds may be bought as part of a long-term investment strategy – to help you meet retirement or college funding objectives.
Bonds and money market investments are both susceptible to inflation risks. Through its consumer price index (CPI), the Bureau of Labor Statistics pegs an average annual domestic inflation rate of 3 percent. Integrate stocks within your diversified portfolio of bonds and money market assets to improve your chances for long-term growth above inflation.