When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.
Money market vs Capital market
Investors are almost universally advised to keep their money spread across a variety of assets. An important way to do this is by investing in both the money market and capital market to achieve a healthy mix of liquidity and returns.
Big ideas
- The basic functions of money markets and capital markets are to let companies operate and grow by asking for other people’s money as loans or investments.
- The most important distinction between money markets versus capital markets is that the former trades in short-term loans, while the capital market handles long-term investments and credit.
- Especially during uncertain times, money-market investments are seen as a safe haven for your money, but this means they don’t earn particularly good returns.
QUOTE
“If you would know the value of money, go and try to borrow some.”
It’s a basic principle of economics that money’s value is linked to time. A hundred pounds today is worth more than a hundred pounds in a year. This is because you can use that sum to make more money in the meantime by investing or just by leaving it in a savings account
One major consequence of this is that, should someone want to borrow cash from you, they have to pay for the privilege. The simplest example of this is keeping money in a bank account. The bank can use that money to make profitable loans to other people so they pay depositors a small interest. Bank deposits are, in accounting terms, little different from lending money to the bank: they’re an asset to you and a liability to the bank.
There are numerous other ways of allowing banks and other companies to use your money in exchange for a financial return. These include the finance and capital markets.
One major consequence of this is that, should someone want to borrow cash from you, they have to pay for the privilege. The simplest example of this is keeping money in a bank account. The bank can use that money to make profitable loans to other people so they pay depositors a small interest. Bank deposits are, in accounting terms, little different from lending money to the bank: they’re an asset to you and a liability to the bank.
There are numerous other ways of allowing banks and other companies to use your money in exchange for a financial return. These include the finance and capital markets.
Financial markets vs Capital markets vs Stocks vs Money markets
The various terms commonly used to describe marketplaces for investments can get confusing; this is largely because there is so much overlap between them.
Here are some simple definitions to get started:
Here are some simple definitions to get started:
- Financial markets refer to any organised forum where financial instruments are traded.
- Stocks provide you with a tiny percentage of ownership in a company. That is, your investment’s value depends on that of the business as a whole.
- The money market is where short-term corporate debt is bought and sold. A company in need of some cash offers lending opportunities to the public at an interest rate acceptable to both parties.
- Capital markets handle both stocks and bonds – both are ways for companies to raise large amounts of money. Bonds are also a form of debt but are often structured around terms of 10 years or more.
These terms do not refer to any particular platform like the London Stock Exchange. Rather, they can comprise all investment activity in an industry, country, or even worldwide. All of these markets are also closely coupled: an upset in stock prices is bound to affect the money market, or vice versa.
As you can see, most of the financial market as a whole consists of the money market and capital market. Both can be good investments, though it’s important to understand the ins and outs of each before risking any money.
As you can see, most of the financial market as a whole consists of the money market and capital market. Both can be good investments, though it’s important to understand the ins and outs of each before risking any money.
Money market and capital market differences and similarities
Technically, any debt taken on by a company, bank, or government for less than a year is part of the money market. In practice, we usually use the term to describe transferable short-term debt: instruments that can be bought and sold by the owners, just like shares, derivative contracts, or other assets.
The difference between capital and money markets is purpose
Let’s imagine two companies that are very different in terms of growth stages and financial needs:
Anne’s Awesome Aquariums is doing well: making a profit and with some money in the bank. An export order of £1,000,000 has just caught her off guard, though. She can certainly fulfil it within the specified 3 months, but only if she can somehow afford the raw materials.
Luckily, she can turn to the money market. Since her business is established and healthy, this may be a quicker, cheaper way of paying her suppliers than applying for a bank loan. In other words, the money market is all about liquidity. In this sense, “liquidity” refers to cash flowing through the economy at a healthy, steady pace.
Harry’s Hilarious Haircuts also needs money, but not to cover the short-term costs of doing business. Instead, he wants to increase the number of locations in his barbershop chain from 10 to 25. Now, each new shop will need time to get on its feet and start generating a profit. He won’t be able to repay the money he needs to borrow in less than a year. He can, however, offer a mini-bond of £10,000,000 with a term of 5 years to investors in the capital market. This will allow him to expand his business.
This may be a good option for Harry if he does not want to give up equity (i.e. ownership) in the company. At the end of 5 years, he’ll have to repay £13,000,000 (initial sum + interest) to the people who bought his bond. If it doesn’t seem likely that he’ll be able to afford this, nobody will buy his bonds. In this case, he can also sell shares in the business, another way in which the capital market operates.
Anne’s Awesome Aquariums is doing well: making a profit and with some money in the bank. An export order of £1,000,000 has just caught her off guard, though. She can certainly fulfil it within the specified 3 months, but only if she can somehow afford the raw materials.
Luckily, she can turn to the money market. Since her business is established and healthy, this may be a quicker, cheaper way of paying her suppliers than applying for a bank loan. In other words, the money market is all about liquidity. In this sense, “liquidity” refers to cash flowing through the economy at a healthy, steady pace.
Harry’s Hilarious Haircuts also needs money, but not to cover the short-term costs of doing business. Instead, he wants to increase the number of locations in his barbershop chain from 10 to 25. Now, each new shop will need time to get on its feet and start generating a profit. He won’t be able to repay the money he needs to borrow in less than a year. He can, however, offer a mini-bond of £10,000,000 with a term of 5 years to investors in the capital market. This will allow him to expand his business.
This may be a good option for Harry if he does not want to give up equity (i.e. ownership) in the company. At the end of 5 years, he’ll have to repay £13,000,000 (initial sum + interest) to the people who bought his bond. If it doesn’t seem likely that he’ll be able to afford this, nobody will buy his bonds. In this case, he can also sell shares in the business, another way in which the capital market operates.
The similarity between capital markets vs financial markets is safety
The examples above use mid-sized companies for simplicity. In practice, though, most money-market and capital transactions involve large corporations as both buyers and sellers.
The result is they are heavily regulated. Becoming a publicly listed company, for instance, requires a small army of lawyers and accountants. Issuing bonds or commercial paper is only slightly less complicated and generally requires an excellent credit rating.
The result is they are heavily regulated. Becoming a publicly listed company, for instance, requires a small army of lawyers and accountants. Issuing bonds or commercial paper is only slightly less complicated and generally requires an excellent credit rating.
DEFINITION
The commercial paper describes any kind of short-term, unsecured debt instrument issued by a company. Commercial papers are traded in the money market.
Offerings on the money and bond markets are also closely scrutinised by a plethora of analysts, providing further security to ordinary retail investors. This is also true of publicly traded companies, though there is a greater element of uncertainty in that case.
In terms of the money market vs stock market, the former offers nearly guaranteed, though modest, returns. Stocks remain good investments…but only to the extent they fit into your long-term financial plans. You should maintain a diversified portfolio and not invest money you may need within 5 years in stocks.
In terms of the money market vs stock market, the former offers nearly guaranteed, though modest, returns. Stocks remain good investments…but only to the extent they fit into your long-term financial plans. You should maintain a diversified portfolio and not invest money you may need within 5 years in stocks.
The difference between capital markets vs money markets is timing
The key distinction between money market and capital investments is the amount of time an investor holds them. Both can, at least in theory, be sold to other investors. Although you’re more likely to hang on to money market assets until they reach maturity, they are also liquid and can usually be exchanged for a fair price on short notice.
This makes the money market an attractive place to temporarily park cash. Perhaps you’re waiting to see which way the economy will go in the next few months, or you’re taking your time to investigate other investment opportunities. When choosing between the money market vs stocks, you have to accept that stocks can easily dip in value in the short term, or may be impossible to sell at the price you’d hoped for.
Compared to the stock market, money in bonds or short-term promissory notes is basically guaranteed to hold its value. Almost the only way you can lose money on these is if the issuing company or government is truly unable to honour its obligations, and this almost never happens aside from “junk” bonds.
This makes the money market an attractive place to temporarily park cash. Perhaps you’re waiting to see which way the economy will go in the next few months, or you’re taking your time to investigate other investment opportunities. When choosing between the money market vs stocks, you have to accept that stocks can easily dip in value in the short term, or may be impossible to sell at the price you’d hoped for.
Compared to the stock market, money in bonds or short-term promissory notes is basically guaranteed to hold its value. Almost the only way you can lose money on these is if the issuing company or government is truly unable to honour its obligations, and this almost never happens aside from “junk” bonds.
DEFINITION
Junk bonds are long-term debts, typically issued by unstable governments, struggling businesses, and companies looking to acquire their competitors. Their rates of return maybe 15% or more, but there’s also a significant risk of default (being repaid late or never).
Aside from times of great uncertainty, though, the relative performance of the money market vs the stock market is almost guaranteed to be poor. If you’re willing to invest for the long term, the capital market (meaning a mixture of stocks and bonds) is usually the way to go. Compared to money market securities, capital market securities have greater volatility but are better bets overall.
The similarity between the capital market vs financial markets is economic importance
We’ve already mentioned that the economic functions of money markets and capital markets are, respectively, to provide liquidity and to give promising businesses access to the funds they need to grow. The way the latter works is obvious: railways, capital-intensive industries, and modern tech giants could not exist without stock market investment and bond issues.
The role of the money market is more subtle. Very few banks and large companies keep huge reserves of actual cash. This means that they often have to make use of money market characteristics such as predictability and liquidity. These provide easy access to quick cash they may need to cover ordinary expenses like wages, inventory, and depositor withdrawals. When banks and other enterprises are no longer willing to purchase debt from each other, as happened in 2008, the whole system comes crashing to a halt.
The role of the money market is more subtle. Very few banks and large companies keep huge reserves of actual cash. This means that they often have to make use of money market characteristics such as predictability and liquidity. These provide easy access to quick cash they may need to cover ordinary expenses like wages, inventory, and depositor withdrawals. When banks and other enterprises are no longer willing to purchase debt from each other, as happened in 2008, the whole system comes crashing to a halt.
Money market and capital market: differences in investment products
When comparing the money market and stock market, differences in people’s appetites for risk are often what determine their individual choices of investment vehicles. The key here is to understand that, in the bond and money markets, you make your profit when you buy. The rate of return is (usually) fixed and guaranteed, and the risk of not getting your money back is quite low. The money market and capital market distinguish between debt secured by specific assets and that backed by a company’s reputation, though the vast majority is unsecured but trustworthy.
In the stock market, however, any given share or combination of them can easily lose value. It’s likely that they will recover in time, but this makes little difference when you need to cash out part of your portfolio in a hurry.
In the stock market, however, any given share or combination of them can easily lose value. It’s likely that they will recover in time, but this makes little difference when you need to cash out part of your portfolio in a hurry.
Average U.K. share prices in recent times
Source: The London Stock Exchange. Past performance is no guarantee of future results.Stock prices can fall by 10% or more in a month. This is fine if you have sufficient savings or income to ride out the storm, but money market products may be a better choice for protecting your nest egg if you really need it.
Speaking of uncertainty, money market assets usually aren’t as potentially lucrative as medium-term bonds but are considered slightly safer. One reason for this is that the money market is extremely liquid, and investments can quickly be sold if needed. The other is that longer terms introduce a special kind of uncertainty.
If a company, municipality, or government is in good financial shape today, it shouldn’t have a problem repaying creditors in three months. Stretching that timeframe into years gives all kinds of unexpected stuff a chance to happen. Over the past two decades, almost all of us have been surprised by the tech bubble in 2000, the banking crisis of 2008, Brexit, Covid, and the Russian invasion of Ukraine, to name only a few. When times are uncertain, and there’s every reason to say they currently are, the short-term money market is often the safest option, even when effective rates are below the inflation figure.
Speaking of uncertainty, money market assets usually aren’t as potentially lucrative as medium-term bonds but are considered slightly safer. One reason for this is that the money market is extremely liquid, and investments can quickly be sold if needed. The other is that longer terms introduce a special kind of uncertainty.
If a company, municipality, or government is in good financial shape today, it shouldn’t have a problem repaying creditors in three months. Stretching that timeframe into years gives all kinds of unexpected stuff a chance to happen. Over the past two decades, almost all of us have been surprised by the tech bubble in 2000, the banking crisis of 2008, Brexit, Covid, and the Russian invasion of Ukraine, to name only a few. When times are uncertain, and there’s every reason to say they currently are, the short-term money market is often the safest option, even when effective rates are below the inflation figure.
DEFINITION
An investment or portfolio’s real rate of return is the percentage income or growth minus fees and taxes and adjusted to reflect the consumer inflation rate. An asset may be growing in nominal terms yet still be losing ground against inflation.
Some popular money market investments
Compared with money market instruments, capital market instruments have traditionally been less accessible to ordinary people. This is despite the capital market being better known. Many money market investments are, in fact, available over the counter of your local bank or building society.
- Certificates of deposit are simply agreements between you and your bank to keep an agreed amount of money with them for a certain amount of time. The size of the deposit and the term during which you won’t have access to the money are highly flexible, with periods of one month to several years available. It is usually possible to withdraw your deposit early by paying a penalty fee.
- Money market accounts aren’t especially popular in the United Kingdom, perhaps due to investment ISAs (Individual Savings Accounts) mostly being the better option. A few banks do offer them, though: they are essentially savings accounts with a higher-than-normal interest rate but strict conditions on minimum balances, withdrawals, and so forth.
- Money market funds can be combined with ISAs to reap tax benefits. These allow you to invest in a professionally managed “basket” of short-term debts and longer-term bonds that are close to their maturity date. They are considered stable, but there is still a chance that your investment in these will lose value.
- U.K. government gilts are bonds issued by the government and are extremely safe, though the returns are not stellar. You can purchase these directly from the U.K. Debt Management Office (though this is rather cumbersome) or in smaller amounts from brokers. Both long- and short-term gilts are available. Several other countries allow non-nationals to lend them money in the same way.
- Apps and online trading platforms sometimes give you the option of investing in money market instruments, usually by choosing a fund rather than buying stakes in individual short-term bonds. Most amateur investors should be cautious while using these tools, but they do have the advantage of making it easy to invest in offshore money market products and thereby diversifying your investments.
When should a person choose to invest in the money vs capital market?
The first thing most financial advisors will tell you is that putting all your eggs into one basket is rarely a good idea. This may seem trite, but it’s excellent advice that’s not followed often enough.
Given that none of us can foresee the future, your investment portfolio should ideally be spread among a mixture of stocks, money-market investments, and longer-term bonds. Each of these has its own set of advantages and disadvantages, and all can be invested in using mutual funds that take much of the guesswork out of the equation.
Given that none of us can foresee the future, your investment portfolio should ideally be spread among a mixture of stocks, money-market investments, and longer-term bonds. Each of these has its own set of advantages and disadvantages, and all can be invested in using mutual funds that take much of the guesswork out of the equation.
Bonds allow you to lock in a predictable return for several years but can also cause you to miss out when interest rates rise. Short-term money-market instruments are very safe but don’t necessarily compare well even to high-yield savings accounts. A well-chosen, diversified portfolio of stocks can potentially outperform inflation but can also sink in tandem with the economy at large.
The greatest advantage of the money market is its liquidity. If the value of other investments should start to improve, you can easily sell your money market investments and change the emphasis of your portfolio. Should the outlook continue to be unsatisfactory, you can also hang on to them for several months. Leaving your options open reduces your exposure in a way while also allowing you to take advantage of new opportunities.
The greatest advantage of the money market is its liquidity. If the value of other investments should start to improve, you can easily sell your money market investments and change the emphasis of your portfolio. Should the outlook continue to be unsatisfactory, you can also hang on to them for several months. Leaving your options open reduces your exposure in a way while also allowing you to take advantage of new opportunities.
Recap
The difference between money and capital markets is simple in essence: money markets deal only in corporate and other debts meant to be repaid in under a year, while capital markets are based on stocks, long-term debt, and other investments.
On a practical level, placing your faith in the money market means that you won’t lose too much ground. Your money also won’t grow very quickly and may not even keep up with inflation. Investing in the capital market can potentially earn a greater return but also leaves you exposed to various contingencies.
In general, it’s best to balance the risks and potential rewards of different types of investments by maintaining a balanced portfolio. The money market is particularly useful as a way of storing money safely for periods of a few months while waiting for better opportunities to come along.
On a practical level, placing your faith in the money market means that you won’t lose too much ground. Your money also won’t grow very quickly and may not even keep up with inflation. Investing in the capital market can potentially earn a greater return but also leaves you exposed to various contingencies.
In general, it’s best to balance the risks and potential rewards of different types of investments by maintaining a balanced portfolio. The money market is particularly useful as a way of storing money safely for periods of a few months while waiting for better opportunities to come along.
FAQs
Q: How are money markets and capital markets interrelated?
Most large corporations and banks make use of both. They may buy and sell money market products based on their immediate cash flow position and the short-term economic outlook.
In some cases, they may also have some leeway in choosing to obtain financing from either the capital market vs money market. Investors and lenders may choose to buy either kind of debt depending on available interest rates and risk profiles.
Speaking in general, the money market and capital market interest rates track each other, but with the money market moving more rapidly.
In some cases, they may also have some leeway in choosing to obtain financing from either the capital market vs money market. Investors and lenders may choose to buy either kind of debt depending on available interest rates and risk profiles.
Speaking in general, the money market and capital market interest rates track each other, but with the money market moving more rapidly.
Q: What is the difference between the money market and capital market?
The principal capital vs money market distinction is that capital markets consist of a variety of different types of investments. Some of these confer ownership of part of a company on the investor, others offer predictable returns on long-term debt, while a few possess no intrinsic value but are based on the prices of other assets. The money market is more homogenous and trades only in short-term, low-risk debts. Since the companies and financial institutions taking on this debt are carefully vetted, money-market investments are considered very safe.
Q: What are the advantages of the money market and capital market?
Both the money and capital markets depend on the economy as a whole. When conditions are bad, and money is tight, nearly all investments suffer. The principal advantage of capital and especially the stock market is that it makes it possible to earn good returns. The bad side of this is that it’s equally possible to lose plenty of money trading shares, at least when looking ahead less than two to five years. Money market investments only yield low or even negative real interest rates but do so in a predictable way – investors in the money market won’t suffer unexpected, heavy losses.
Q: What is the biggest disadvantage of money market investments?
The largest problem with all money market assets is that, while they never do incredibly well, they definitely struggle to hold their own during difficult economic times. Lenders in the working capital marketplace used by companies and financial institutions have to compete with the LIBOR rate at which banks lend each other money. This currently stands at about 4.25%, while inflation is around 10%. This means money market investments aren’t keeping up. On the other hand, they remain a competitive option for keeping wealth for short periods due to their liquidity.
Q: What are the 3 types of capital market?
The two principal components of the capital market, at least from the perspective of a retail investor, are stocks and bonds. Other kinds of securities, like derivatives, foreign exchange, and alternative assets (like venture capital), are also considered part of the capital market.
Q: Can money markets lose money?
Almost the only way you can lose part or all of a money market investment is if the company that issued it crashes and burns. Credit rating agencies, the Financial Conduct Authority (in the United Kingdom), and similar bodies take great pains in ensuring that unstable companies can’t sell short-term debt in the money market.
However, money markets’ rates of return are loosely linked to the base rate of the Bank of England, which is currently lower than inflation. So, though you will almost certainly receive the amount invested plus interest, your real rate of return may well be negative. Transaction and other fees make this situation even worse.
However, money markets’ rates of return are loosely linked to the base rate of the Bank of England, which is currently lower than inflation. So, though you will almost certainly receive the amount invested plus interest, your real rate of return may well be negative. Transaction and other fees make this situation even worse.
Q: Do money markets pay dividends?
One of the attractions of the stock market is the possibility of dividends: cash payouts made to investors as a company’s profits permit. The short-term debts bought and sold on the money market typically do not pay any dividends. Mutual funds that primarily focus on the money market, however, generally try to maintain a stable share price, paying out excess cash to their investors in the form of dividends.
