Short term solution in the current environment
As our economy is technically in a recession investment options are very challenging. A great place to invest in the short term is the money market. Accounts can be opened at all financial institutions such as your local bank. Why?
Well because it is very difficult at the moment to get a return of around 7% with extremely low risk of losing your capital. I say low risk because there is a very extreme possibility that the bank where your investment is made could run into trouble as did in the case of Africa Bank.
What is it all about?
A money market account trades in bank instruments called “paper”, such as Treasury bills, Banker’s acceptances, certificates of deposit, bills of exchange which all trade in a period of less than a year.
The money market trades at the so called ‘interbank’ level where banks lend and borrow to each other. These wholesale rates are higher than the retail rates offer by banks on their savings accounts.
Money markets do better when interest rates rise
The current rate varies between as the underlying instruments reach their varying maturing rates. These instruments are also dependent on the interest rate cycle. As interest rates rise so too will money market rates.
Make sure you understand the actual rate offered
The nominal rate is the actual rate of return – normally annual. The effective rate is the rate achieved by reinvesting the interest received and compounding it back into the investment.
Nominal rate of 7% per annum yields and effective 8.25% over a 5 year period.
If you draw out the interest then you do not get the effective rate. You actually get the nominal rate.
Real rate is the adjusted rate received after subtracting the inflation rate.
In an environment where cash is king money market accounts are very useful parking bays.