The global financial system is dynamic and can be quite complex. Although this can make it challenging to understand, having a grasp on how the global financial system works is essential for investors of assets affected by macroeconomic factors that are constantly changing. One important concept to understand is the difference between the money market and the capital market, which are two separate parts of the global financial system.
Basic difference between the money market and capital market
The money market refers to the overall activity of trading short-term debt between governments, banking institutions, financial firms and corporations. Capital markets encompass the trading of stocks and bonds purchased by individual investors, brokers and financial institutions.
Many think of the money market as a place for storing cash for a short length of time. Usually, this will mean around a year or less. Money markets allow businesses and governments that require cash to fund operations to be able to obtain the cash they need quickly. Borrowers will utilize money markets for their daily operations while lenders participate in money markets to receive a return on spare cash.
The capital markets are where the buying and selling of stocks and bonds occurs for usually long-term investment purposes. Corporations will issue stocks and bonds in order to raise capital to invest back into their business model with the objective of growing their business. Purchasers of the stocks and bonds are investing in the companies in order to share in the benefits of the growth in the issuing corporations.
Risk vs. reward
When making investment decisions about where to put your money to work, it is always smart to take the potential risk of loss into consideration before choosing to invest. This should then be balanced against the potential reward of a particular investment. When it comes to money markets and capital markets you should understand the risk and reward balance is different between these two investment market vehicles.
Money market returns are significantly lower than other types of investments in the capital markets. Some of the common financial instruments in the money markets are deposits, bills of exchange, collateralized loans and banker’s acceptances.
On the other hand, corporate bonds tend to pay much higher interest rates than money market instruments. Also, stocks have the potential to provide big returns on appreciating value. However, if a company performs poorly, it is easy to end up losing significant money for stock investors. Additionally, if the company ends up defaulting on its debt and files bankruptcy, bondholders may not be able to receive their returns.
Money markets and capital markets for your portfolio
As an investor it may be a good idea to consider incorporating money market instruments and capital market assets into your investment portfolio. However, exactly when and how much you want to invest will depend on the current economic environment as well as what you are trying to accomplish in your investment endeavors. Make sure you consider your own risk tolerance and financial goals before rebalancing your portfolio.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. Any opinions are those of the author and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Raymond James and its advisors do not offer tax or legal advice. You should discuss any investment decisions, tax or legal matters with the appropriate professional.
An investment in a money market fund is neither insured nor guaranteed by the FDIC or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.
Investors should consider the investment objective, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other important information, is available from your financial advisor and should be read carefully before investing.