Money Market Investment

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Money market investment is not investing, technically. It's savings. When you put your money into a money market account, you're hoping to preserve those dollars, not increase them.

You do get paid a small amount of interest, but it doesn't keep up with inflation. Therefore, in the long run money kept in money market funds loses purchasing power.

Money market fund accounts carry very little risk, so they pay very little.

Investing is when you want to increase your capital. To do that, you must assume greater risk.

For example, some financial advisers have been telling their clients to move money out of money funds and into short term bond funds, because those bond funds are paying a (slightly) higher rate of interest.

A Money Market Investment is Principal Risk Free

That's true, but it's also true that those bond funds are riskier. You can lose money. If short term interest rates go up, because of the market or because of the Federal Reserve, then the Net Asset Value (NAV) in those bond fund shares will go down.

Is it worth the risk? That's for you and your financial adviser to decide.

It's also true that if interest rates go down farther, the NAV of a short term bond fund will go up.

Unfortunately, interest rates are now so low that there's little room for them to go down further. It could happen -- it did in Japan -- but not far.

If inflation returns, there will be pressure on the Chairman of the Federal Reserve to raise interest rates to fight it, as Paul Volcker did in the early 1980s. This would also help boost the value of the US dollar. However, it's also true that the US government is continuing its policy of devaluing the US dollar to make it easier to pay off the national debt.

Still, even without drastic Fed action, normal small fluctuations in interest rates can affect bond fund valuations.

Money Market "Investment" Consists of Short Term Commercial Paper of Corporations, Financial Institutions and State and Local Governments

Businesses and local governments have found that by selling short term notes they can pay a lower interest rate than if they borrowed the money from a bank. So they issue what's called commercial paper. So long as they keep the maturity date under 270 days, the avoid the expense of registering with the Securities and Exchange Commission under the terms of the Securities Act of 1933.

Typically, however, the maturity of these notes is much shorter than 270 days - from one to 60 days. That makes it eligible collateral for banks to use to borrow at the Federal Reserve's discount window (the maturity limit for such collateral is fifty days). This is important because banks are one of the major markets for this type of financing, which is ironic considering that one of its purposes is to evade the higher interest rates banks would charge for a direct loan.

Only corporations with high credit ratings can sell commercial paper. Each issue is rated by S&P and Moody's. If a company doesn't have a sufficiently high credit rating on its own, it can enhance its rating with credit support. This can be in the form of a letter of credit from a highly rated company, especially a financial institution or insurance company. Or it can back the issue up with high quality collateral.

However, if you buy commercial paper direct instead of putting your money into a money market fund, look for the highest ratings. That's A1 from S&P and P1 from Moody's.

So keep your emergency fund and other short term savings money in a money fund, but a money market investment is just not viable. To increase your capital, you need to take more risk.

Next: Online Money Market Accounts -- about looking for money market funds while online.

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