The Advantages of a Money Market Hedge

Money market instruments are safe, liquid investments.

Money market instruments are safe, liquid investments.

If you are starting to invest -- or maybe you already have -- all your money doesn't have to go into stocks, commodities and bonds. These assets can be risky, but by putting some of your investment dollars in money market instruments you offset some of that risk. As you build your future these assets let you know exactly what you are going to get in gain in advance, allowing you to plan for purchases or save on a schedule. Money markets provide several advantages, but there are certain things to be aware of as well.

Money Markets

Liquid and short-term, the money market is where lenders and borrowers come together. Certificates of deposit (CDs), Treasury bills, commercial paper and bankers acceptance are all examples of money market instruments. Lenders use the money market to make a return on their money, while borrowers use the funds to finance projects or pay bills. The instruments are short-term in nature, and mature in one year or less. You can also stash your cash in money market funds. These funds invest in a wide array of money market instruments, pay out interest and are totally liquid because you can exit the fund at any time (fees may apply). Money market funds don't have a maturity date since the fund is managed on an ongoing basis by a fund manager.

Safety

The main advantage of money market instruments is safety. These instruments are considered low risk, and because they are short-term you get your expected cash flow fairly quickly. Investors and corporations alike use the money market as a place to park cash, usually getting a better return than that offered by a traditional savings account, but still with security and easy of access.

Fixed Return

When you buy a money market instrument you know what you are getting. There is a stated return, and if you hold the instrument to maturity you will get what you expect. By hedging some of your portfolio with these instruments you are assured that at least some of your money will bring in a return and will be protected from loss should the market fall. Since these instruments are considered safe, the return is often significantly lower than what you might get in a stock or mutual fund.

Liquidity

Most money market instruments are very liquid and therefore allow you quick access to your capital. By investing in CDs or Treasury bills you can make a small return on your money but can also access that money if you need it. If you cash in early though you give up some of the interest you would have earned if you held the product to maturity. The minimum penalty for early withdrawal of a CD is seven days' interest. This is not the norm though. Banks may pay no interest if you cash in a 30-day CD early, and expect to give up several months of interest on a longer term CD if you cash it in early. When you sell a Treasury bill before maturity, you get what the market will pay for it; you may make a small profit or take a small loss depending on the movement of interest rates since your purchase.

FDIC Insured

Some money market instruments, such as CDs issued by your bank, are insured by the Federal Deposit Insurance Corporation. If the the bank goes bankrupt and cannot repay the money owed to you, the FDIC will cover your losses up to $250,000. The coverage does not cover losses related to mutual funds, stocks, bonds, annuities and other investments.

 

About the Author

Cory Mitchell has been a writer since 2007. His articles have been published by "Stock and Commodities" magazine and Forbes Digital. He is a Chartered Market Technician and a member of the Market Technicians Association and the Canadian Society of Technical Analysts. Mitchell holds a Bachelor of Management in finance from the University of Lethbridge.

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