Apart from banks, financial markets are one way to borrow and lend money. There are two types of financial markets: money market and capital market. In the money market, assets are usually held for a short period. On the other hand, assets are held for an extended period in the capital market and have a direct or indirect effect on capital. The capital market features an equity market and a debt market. Here we will detail the differences between the money market and capital market.
What is the Money Market?
The money market is considered to be a safe haven for individuals, banks, companies or governments as they can park cash there for a short time. A short time can usually be considered under a year. The market helps individuals or entities get cash quickly at a fair cost and allows companies to use excess cash.
The low risks of the money market are associated with modest returns. A money market instrument would include a deposit, a collateral loan, an acceptance, and a bill of exchange. Money markets include institutions such as the central bank, commercial banks, and insurance companies.
How are transactions made in the money market?
Most trading in the money market occurs off-exchange or over-the-counter(OTC). This means that there is little involvement by an exchange. In the short term, the market’s role is to provide businesses with short-term credit and liquidity. This facilitates the working capital needs of businesses and industries.
What is the Capital Market?
Generally, the capital market involves the long-term trading of financial products, such as stocks, bonds, and debentures. These investments are used for long-term financing and long-term capital requirements. A capital market is a dealer market and an auction market that comprises two categories: the primary market and the secondary market.
In the primary market, new securities are offered to the public. In the secondary market, issued securities are traded among investors. If you were to go buy Apple or Tesla stock, you would most likely be purchasing this from an investor trying to sell it. Therefore, you would be utilizing the secondary markets. Note, there can be many benefits of investing in stocks.
Now that you understand the basics, lets dive into the pros and cons of both the money market and capital market.
Pros and Cons of the Money Market
Investing in the money market can be beneficial for investors. However, there are some pros and cons.
There are many advantages, some are listed below.
- Money market investments are excellent safe havens when stock market volatility is high. Investors turn to the money market when they are unsure where to invest their money. Accounts and funds invested in money markets are often viewed as having lower risk than those invested in stocks and bonds (capital market). Additionally, investors in the money market typically earn low single-digit returns. Even these small returns can be quite attractive, even in a down market.
- Securities that trade in limited volumes or have little interest are typically not included in money market funds. They generally trade in entities or securities in high demand. Investors may buy and sell them relatively easily because they tend to be more liquid. There may be some cases where the shares are highly liquid. That being said, the audience for these securities will be very limited. In such a scenario, getting in and out of the investment could be difficult.
There are some cons or disadvantages of investing in the money market.
- Even small annual fees in a money market account can eat up a substantial chunk of returns. This is especially true considering investors will earn a very small percentage. Investors in money market funds may have a harder time keeping up with inflation. The negative impact of fees on returns may vary from account to account and from fund to fund.
- Because risks are lower in the money market, the returns are also low. Therefore, if the return is 3-4% and the inflation rate is at around 5-6%, investors will be losing purchasing power.
- A common stock’s return over time has been about 8% to 10%, including recessions. An investor who invests in a money market mutual fund, which may yield only 2% or 3%, may miss out on an opportunity for a higher return. In turn, this can affect an individual’s wealth-building ability significantly. A comparison of both the markets is essential as per investors’ risk appetite. You need to divert focus on ensuring investment risk, and Nectar’s Market Place can be helpful.
Pros and Cons of the Capital Market
Let’s look at some advantages of investing in the capital market.
- The capital market facilitates the flow of money between so many investors, including people who provide capital and people who borrow capital.
- Bonds traded on the capital market give investors a higher interest rate than bank deposits, and shares offer dividends.
- Investors who invest in shares in the capital market will get ownership rights to those shares and increase investment value.
- The capital market provides a variety of investment instruments for investors, which provide long-term performance and tax benefits.
The disadvantages of investing in the capital market include:
- Investments in the capital markets can be risky because they can fluctuate quite a bit at times with price fluctuations. Since the capital market fluctuates greatly in terms of price, investments won’t give you a fixed income.
- Investing in the capital market can be confusing, as there are so many investment options to choose from, making it difficult to invest.
- A brokerage fee or commission is charged when buying or selling capital market securities, eventually increasing transaction costs.
Money Market and Capital Market – Summary
It is probably a safe assumption to say that you interact with both the money market and capital market. That being said, you may not know the differences between them. We hope that this article was able to inform you about the differences between the money market and capital market, as well as give you insight into the pros and cons of each.