An overview of bonds and money market securities
What you want to consider first and foremost is that bonds and money market securities are both financial vehicles that are labeled as “debt instruments.” However, they are different types of investments. They are basically different based on the following:
- issuance of new securities
- length of time it takes each of them to reach maturity
- the interest rates which are paid
- the way in which the interest is earned on each
- their relationship to changes in interest rates
Another fact to consider is that bonds will mature in 5 to 30 years, depending on the type of bonds they are, whereas money market securities typically mature over a period of 9 months or less.
How interest is earned and paid
Bonds are usually issued with a clearly stated interest rate which and interest is typically paid on a semi-annual basis. On the other hand, money market securities will normally be issued at a discounted rate towards their final maturity value. The key difference is what the investor is going to earn for holding to these until they actually mature. Another difference is that lengthier maturity periods tend to discourage investors because they are looking for a much greater ROI when investing for the long haul.
Ironically, the interest rates paid on most bonds is typically higher than those of money market securities. This is primarily due to the higher levels of inflation risk and the uncertainty that it breeds with money market securities. This aspect is in reference to what is called a “yield curve” and there have lengthy yield curve time periods that were inverted throughout history. This refers to periods of time where there are only inflation risks which are short term in nature which had been perceived to be higher and where the long-term risks were considered to be relatively low or stable.
The relationship to changes in the interest rate
For the most part, there is what is commonly called an inverse relationship between money market securities and:
A bond’s market value will normally display an inverse relationship to longer-term-of- maturity bonds and are typically more volatile than bonds that have a shorter maturity term. The major advantages that you have when investing in money market securities versus bonds is the fact that your money is readily available should you want to withdraw those funds.
The key disadvantage with money market securities is that they have lower rates of interest so the ROI is considerably smaller than with bonds. Conversely, the main disadvantage with bonds is that you will need to wait a full year before you can withdraw funds. Additionally, you will most likely be penalized three months of interest for withdrawing funds early with bonds during the first 1 to 5 years.