Money Market vs. Short-Term Bonds: An Overview
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.
Key Takeaways
- The money market is part of the fixed-income market that specializes in short-term government debt securities that mature in less than one year.
- Buying a bond is effectively giving the issuer a loan for a set duration; the issuer pays a predetermined interest rate at set intervals until the bond matures.
- Money markets are extremely low risk, with a typical par value of $1.
- Short-term bonds carry a greater degree of risk depending on the issuer, which may be a company, a government, or an agency.
Money Market Securities
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.
Lower returns are realized when compared to other investments because of the liquidity of the money market.
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.
Short-Term Bonds
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.
Most bonds can be bought through a full-service or discount brokerage. Government agencies sell government bonds online and deposit payments electronically. Some financial institutions also transact government securities with their clients.
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 ratesthan other securities. Buying and holding a bond until it's due means receiving the principal and interest according to the stated rate.
The bond owner could lose money if interest rates go up, in the sense of opportunity cost by having the money tied up in the bond rather than invested elsewhere.
What Is the Safest Type of Money Market Fund?
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.
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.
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.
The Bottom Line
There are both pros and cons to investing in money market funds and short-term bonds.
Money market accounts are excellent for emergency fundsbecause 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.
FAQs
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.
Why are short-term bonds better? ›
Bonds with shorter times to maturity are less sensitive to changes in interest rates than longer-term bonds, meaning investors won't suffer as much if rates head higher. Remember, interest rates and bond prices move in opposite directions, so as rates rise, bond prices fall and vice versa.
Is it better to buy bonds or bond funds? ›
Key takeaways. Buying individual bonds can provide increased control and transparency, but typically requires a greater commitment of time and financial resources. Investing in bond funds can make it easier to achieve broad diversification with a lower dollar commitment, but offers less control.
What are the risks of money market? ›
There's no risk of you losing your deposit with a money market account. While money market accounts are considered low-risk accounts, that doesn't mean there aren't small risks to be aware of. The biggest risk a money market account poses is that your money may lose value over time to inflation.
What are the disadvantages of short-term bond funds? ›
Because bond prices and market interest rates move in opposite directions, short-term bonds lose value when interest rates rise. Thanks to their short maturities, though, their losses are more muted than those of longer-term instruments.
Should I invest in bonds or money market? ›
Money market funds will generally outperform bonds in a rising interest rate environment. If interest rates are falling or unchanged, an investor will generally experience better performance from owning bonds.
What is the best Treasury bond to buy right now? ›
7 Best Treasury ETFs to Buy Now
| ETF | Expense Ratio | Yield to Maturity |
|---|
| Vanguard Intermediate-Term Treasury ETF (ticker: VGIT) | 0.04% | 4.7% |
| Vanguard Short-Term Treasury ETF (VGSH) | 0.04% | 5.1% |
| Vanguard Long-Term Treasury ETF (VGLT) | 0.04% | 4.9% |
| iShares U.S. Treasury Bond ETF (GOVT) | 0.05% | 4.7% |
3 more rows3 days ago
After bonds are initially issued, their worth will fluctuate like a stock's would. If you're holding the bond to maturity, the fluctuations won't matter—your interest payments and face value won't change.
Are bond funds safe in a market crash? ›
Even if the stock market crashes, you aren't likely to see your bond investments take large hits. However, businesses that have been hard hit by the crash may have a difficult time repaying their bonds.
Is there a downside to buying bonds? ›
Cons. Bonds are sensitive to interest rate changes. Bonds have an inverse relationship with the Fed's interest rate. When interest rates rise, bond prices fall.
Since money market accounts are insured by the FDIC or the NCUA, you cannot lose the money you contribute to the account—even in the event of a bank failure. You can, however, be subject to fees and penalties that reduce your earnings.
What is the biggest disadvantage of money market? ›
Cons of Money Market Funds
- Your Money Could Earn More Elsewhere. High-risk investments could provide better returns in the long run. ...
- Your Funds Are Uninsured. If you open a CD or a checking, savings or money market account from a bank, your funds are FDIC-insured. ...
- You Can Expect Fees.
Vanguard Treasury Money Market Fund
This fund only invests in US Treasuries and repurchase agreements insured by the federal government, making it among the safest in a category of relatively safe investments. The weighted average maturity of the fund's holdings is 43 days.
Should you sell bonds when interest rates rise? ›
If bond yields rise, existing bonds lose value. The change in bond values only relates to a bond's price on the open market, meaning if the bond is sold before maturity, the seller will obtain a higher or lower price for the bond compared to its face value, depending on current interest rates.
Are treasury bills better than money market funds? ›
The biggest downside of investing in T-bills is that you're going to get a lower rate of return compared to other investments, such as certificates of deposit, money market funds, corporate bonds or stocks. If you're looking to make some serious gains in your portfolio, T-bills aren't going to cut it.
What happens to bond funds when interest rates fall? ›
Bond prices have an inverse relationship with interest rates. This means that when interest rates go up, bond prices go down and when interest rates go down, bond prices go up.
Why do banks prefer short term rather than long term bonds? ›
Short-term rates are typically lower because the lender is less concerned with longer-term interest rate fluctuations. If interest rates rise dramatically, the lender will not have funds tied up in an under-performing loan for a long period of time.
What are the advantages of short term securities? ›
The advantages of short-term debt securities include high liquidity and low interest risk due to their short maturity. However, the benefits tend to be lower compared to long-term debt securities due to lower risk.
Why short term investment is better than long term? ›
There is no clear winner here as both have their pros and cons. Short term investment allows you to achieve your financial goals within a short span, with a lower risk. On the other hand, if you have a greater risk appetite, wanting higher returns, you can select long term investment avenues.
Are longer or shorter bonds better? ›
All else being equal, a bond with a longer maturity usually will pay a higher interest rate than a shorter-term bond. For example, 30-year Treasury bonds often pay a full percentage point or two more interest than five-year Treasury notes.
