Investors looking for a safe haven for their money generally turn to the money market. Because the bulk of investors in the money market are basically lending money to the government and to banks for short periods of time, the trust given this system is justifiable. However, some risks are out there that people should consider before investing in money market accounts.
The Federal Deposit Insurance Corp. (FDIC) insures money deposited into a money market account up to $250,000. So if an investor were to deposit more than that into an account, and the bank failed, the investor would lose any money over $250,000 that he or she put into the account.
Because the average return on a money market account is 2 percent to 3 percent, the risk exists that inflation will outrun that. In that scenario, the investment wouldn't keep pace with the rising cost of living.
Missing the Boat
The average return when investing in the stock market is a lot higher than the return on money market investments, so when people invest in the money market rather than in stocks, they miss out on the chance to make more money. Over time, the average rate of return from the stock market is 8 percent to 10 percent, which is more than triple average money market returns.
Sometimes, the annual fees attached to money market accounts can eat into profits considerably. For instance, if an investor places $8,000 into a money market account, at 3 percent, the yield would be $240. With an annual fee of $30, that means the actual yield is only $210.
Money market mutual funds pose another hazard. In this case, the investment is most likely not insured by the FDIC at all. Furthermore, the brokerage firm may put the money into commercial paper, which is only backed by the reputation of the company, making the money market fund nearly as risky as stocks. Thus, the main point of investing in a money market account -- safety -- is gone.
How Do Money & Capital Market Differ?
Money markets and capital markets together comprise methods of financing in the global financial system. Capital and money markets differ in time...