The market can fluctuate and make various investment vehicles attractive. Throughout 2023, Money Markets were a haven for cash; they returned greater than 5% while possessing little to no risk (Moody’s Analytics).
As an investor, you are trying to find the best possible way to create the highest return on what you own. The current economic environment can be extremely confusing and create a lot of uncertainty. In recent years, bonds have not had the best return when comparing their performance to previous years. Many have been discouraged by their performance, hence the discussion between bonds and cash. Since cash is technically not a legitimate investment, investors can hold cash equivalents, such as CDs, Treasury Bills, or money market funds. For this discussion, we focus on money market funds to differentiate cash equivalents and bonds.
What are the factors that influence the price of a bond? This can get a little confusing, but for simplicity, you want to focus on the duration as well as the quality of credit. As many know the U.S. is heavily trusted with its credit hence there is not much worry here. However, in terms of duration, this is the missing piece. Duration is a term that references the sensitivity to the movement of interest rates. In turn, duration will tell you how long it will take for you to return your initial investment. The higher a bond’s duration, the more its value will fall as interest rates rise. This means that if interest rates are done rising, then you face little to no risk of the value of your bond falling.
There are advantages and disadvantages to owning both that of a Money Market and/or a Bond. So how are they different from each other?
Advantages of Owning Bonds
- Bond yields can be higher.
- Bonds will appreciate if interest rates fall.
- Individual bonds allow investors to lock in a yield.
Disadvantages of Owning Bonds
- Rising rates can cause bond prices to go down.
- When owning bonds, you are exposed to the risk of owning an asset that pays below market rates over an extended period.
- Bonds can have a higher risk of default.
Advantages of Owning Money Market Funds
- As an investor you can access your cash in a matter of days
- The price of money market funds is designed to not fluctuate. We have not seen many instances where the share price of a money market falls below $1 per share.
- The interest rate is variable. Money markets purchase lower maturity securities. If the Fed raises interest rates, money markets typically have a higher yield.
Disadvantages of Owning Money Market Funds
- When rates are going down, this will hurt the yield of a Money Market Fund (it will typically go down).
- Typically, the yield on a money market fund is lower. You can expect to have a monthly maintenance fee as well as an excessive withdrawal fee.
Bonds and money market funds can play an important role in a portfolio. Given the lackluster performance of bonds in recent times, it is easy to be frustrated, however, the outlook could change.
Regardless of whether you are wary or optimistic, we believe planning provides our clients, at any stage of life, the confidence to face life’s uncertainties. Through our Strategic Pathways Process, you have a financial roadmap, completely personalized to guide you as your life and needs evolve. If you or someone you know could benefit from our planning process, please call to discuss how we can make a Positive Difference.
