Money Market Vs. Equity Covariance

It pays to know what variables affect your investment.

It pays to know what variables affect your investment.

A large part of financial planning is knowing the different types of funds you can put your money in, as well as how the performance of those funds can be affected by different variables. It pays to familiarize yourself with terms like "money market" and "equity covariance" so you can make informed decisions about your money.

Money Market Funds

Money market accounts look and function very similar to regular bank or credit union saving accounts. These are usually offered at banks and credit unions, although you can acquire them through private financial planners as well. Money market accounts usually earn a higher interest rate than a normal savings account, though you have a limited number of withdrawals you can make per month. The interest you earn is compounded on a daily basis and paid out on a monthly basis. Interest rates can vary for different institutions. They could also vary depending on how much money your account maintains. If you choose to go with a bank or credit union for your money market, be aware that your money will not be insured by the Federal Deposit Insurance Corporation or the National Credit Union Association. However, there is still very little risk associated with this kind of investment.

Equity Covariance

Equity covariance measures the relationship between two variables. Covariance is a probability theory that can measure the extent to which those two variables change together. Investors use this term to see the impact of one variable as related to another, such as when analyzing stock performance or comparing the performance of investments within a portfolio. It is typically used to measure the true degree of diversification within an investment portfolio. In a truly diversified portfolio, different investments will move in different ways in response to certain market conditions, which tends to reduce overall risk. In a non-diversified portfolio, the opposite is true -- every investment in the package will move in the same direction most of the time, magnifying losses in bad market times. Using covariance, an investor can determine how an investment portfolio performs when operating under a certain condition, or variance. For example, an under-diversified portfolio has a high rate of covariance, meaning any single event can have a big impact. This also means it has high level of risk.

The Relationship Between the Two

Money market funds and equity covariance might seem like two completely different concepts. But the two go hand in hand when it comes to choosing the level of risk you want to take when picking a place to store your money and maximize your investment. For example, your money market fund is typically invested in the very short-term lending market. The fund manager assesses the kinds of bonds and loans that go into your money market account. If a stock has a low rate of covariance, it might be a good pick to go into a portfolio with your money market fund.

Deciding How Much Risk to Take

Because money market funds are considered conservative in terms of risk, they can be a good place to earn interest on a short-term basis. Many financial planners suggest money markets for stashing three- to six-months worth of emergency savings because they are very liquid investments -- meaning they it is easy to withdraw cash from them -- and they earns fairly high interest rates. Check with your bank or credit union, or financial planner, for current interest rates if you're interested in opening a money market account to pair with your other investments.

About the Author

Lisa Carlson works as an associate director of recruitment and graduate programs at a public university, and has experience in management, marketing, personal finance and nonprofit organizations. She is a peer-reviewed author on publications for higher education recruiting and holds a B.S. in marketing and a M.B.A.

Photo Credits

  • Jupiterimages/Comstock/Getty Images