The money market is where short-term debt and lending takes place; the capital market is designed for long-term assets, such as stocks and bonds. The former is considered a safer place to park one’s money; the latter is seen as riskier but potentially more rewarding. While the money market and the capital market are both aspects of the larger global financial system, they serve different goals for investors.
Understanding the difference between money market and capital market matters plays a role in understanding the market as a whole. Whether you hold assets that are part of the money market vs. capital market can influence your investment outcomes and degree of risk exposure.
What Is the Money Market?
The money market is where short-term financial instruments, i.e. securities with a holding period of one year or less, are traded. Examples of money market instruments include:
• Bankers acceptances. Bankers acceptances are a form of payment that’s guaranteed by the bank and is commonly used to finance international transactions involving goods and services.
• Certificates of deposit (CDs). Certificate of deposit accounts are time deposits that pay interest over a set maturity term.
• Commercial paper. Commercial paper includes short-term, unsecured promissory notes issued by financial and non-financial corporations.
• Treasury bills (T-bills). Treasury bills are a type of short-term debt that’s issued by the federal government. Investors who purchase T-bills can earn interest on their money over a set maturity term.
These types of money market instruments can be traded among banks, financial institutions, and brokers. Trades can take place over the counter, meaning the underlying securities are not listed on a trading exchange like the New York Stock Exchange (NYSE) or the Nasdaq.
You may be familiar with the term “money market” if you’ve ever had a money market account. These are separate from the larger money market that is part of the global economy. As far as how a money market account works goes, these bank accounts allow you to deposit money and earn interest. You may be able to write checks from the account or use a debit card to make purchases or withdrawals.
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How Does the Money Market Work?
The money market effectively works as a short-term lending and borrowing system for its various participants. Those who invest in the money market benefit by either gaining access to funds or by earning interest on their investments. Treasury bills are an example of the money market at work.
When you buy a T-bill, you’re essentially agreeing to lend the federal government your money for a certain amount of time. T-bills mature in one year or less from their issue date. The government gets the use of your money for a period of time. Once the T-bill matures, you get your money back with interest.
What Is the Capital Market?
The capital market is the segment of the financial market that’s reserved for trading of long-term debt instruments. Participants in the capital market can use it to raise capital by issuing shares of stock, bonds, and other long-term securities. Those who invest in these debt instruments are also part of the capital market.
The capital market can be further segmented into the primary and secondary market. Here’s how they compare:
• Primary market. The primary market is where new issuances of stocks and bonds are first offered to investors. An initial public offering or IPO is an example of a primary market transaction.
• Secondary market. The secondary market is where securities that have already been issued are traded between investors. The entity that issued the stocks or bonds is not necessarily involved in this transaction.
As an investor, you can benefit from participating in the capital market by buying and selling stocks. If your stocks go up in value, you could sell them for a capital gain. You can also derive current income from stocks that pay out dividends.
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How Does the Capital Market Work?
The capital market works by allowing companies and other entities to raise capital. Publicly-traded stocks, bonds, and other securities are traded on stock exchanges. Generally speaking, the capital market is well-organized. Companies that issue stocks are interested in raising capital for the long-term, which can be used to fund growth and expansion projects or simply to meet operating needs.
In terms of the difference between capital and money market investments, it usually boils down to three things: liquidity, duration, and risk. While the money market is focused on the short-term, the capital market is a longer term play. Capital markets can deliver higher returns, though investors may assume greater risk.
Understanding the capital market is important because of how it correlates to economic movements as a whole. The capital market helps to create stability by allowing companies to raise capital, which can be used to fund expansion and create jobs.
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Differences Between Money Markets and Capital Markets
When comparing the money market vs. capital market, there are several things that separate one from the other. Knowing what the key differences are can help to deepen your understanding of money markets and capital markets.
Purpose
Perhaps the most significant difference between the money market and capital market is what each one is designed to do. The money market is for short-term borrowing and lending. Businesses use the money market to meet their near-term credit needs. Funds are relatively safe, but typically won’t see tremendous growth.
The capital market is also designed to help businesses and companies meet credit needs. The emphasis, however, is on mid- to long-term needs instead. Capital markets are riskier, but they may earn greater returns over time than the money market.
Length of Securities
The money market is where you’ll find short-term securities, typically with a maturity period of one year or less, being traded. In the capital market, maturity periods are usually not fixed, meaning there’s no specified time frame. Companies can use the capital market to fund long-term goals, with or without a deadline.
Financial Instruments
As mentioned, the kind of financial instruments that are traded in the short-term money market include bankers acceptances, commercial paper, and Treasury bills. The capital market is the domain of stocks, bonds, and other long-term securities.
Nature of Market
The structure and organization of the money market is usually informal and loosely organized. Again, securities may be traded over-the-counter rather than through a stock exchange. With the capital market, trading takes place primarily through exchanges. This market is more organized and formalized overall.
Securities Risk
Risk is an important consideration when deciding on the best potential places to put your money. Since the money market tends to be shorter term in nature, the risk associated with the financial instruments traded there is usually lower. The capital market, on the other hand, may entail higher risk to investors.
Liquidity
Liquidity is a measure of how easy it is to convert an asset to cash. One notable difference between capital and money market investments is that the money market tends to offer greater liquidity. That means if you need to sell an investment quickly, you’ll have a better chance of converting it to cash in the money market.
Length of Credit Requirements
The money market is designed to meet the short-term credit requirements of businesses. A company that needs temporary funding for a project that’s expected to take less than a year to complete, for example, may turn to the money market. The capital market, on the other hand, is designed to cover a company’s long-term credit requirements with regard to capital access.
Return on Investment
Return on investment or ROI is another important consideration when deciding where to invest. When you invest in the money market, you’re getting greater liquidity with less risk but that can translate to lower returns. The capital market can entail more risk, but you may be rewarded with higher returns.
Timeframe on Redemption
Money market investments do not require you to hold onto them for years at a time. Instead, the holding period and timeframe to redemption is likely one year or less. With capital market investments, there is typically no set time frame. You can hold onto investments for as long as they continue to meet your needs.
Relevance to Economy
The money market and capital market play an important role in the larger financial market. Without them, businesses would not be able to get the short- and long-term funding they need.
Here are some of the key differences between money markets and capital markets with regard to their economic impacts:
• The money market allows companies to realize short-term goals.
• Money market investments allow investors to earn returns with lower risk.
• Capital markets help to provide economic stability and growth.
• Investors can use the capital market to build wealth.
| Money Market | Capital Market |
|---|---|
| Offers companies access to short-term funding and capital, keeping money moving through the economy. | Provides stability by allowing companies access to long-term funding and capital. |
| Investors can try to use interest earned from money market investments to preserve wealth. | Investors can try to use returns earned from capital market investments to grow wealth. |
| Money market investments are typically less volatile, so they’re less likely to negatively impact the financial market or the investor. | Capital market investments tend to be more volatile, so they offer greater risk and reward potential. |
Deciding Which Market to Invest In
Deciding whether to invest in the money market or capital market can depend on several things, including your:
• Investment goals and objectives
• Risk tolerance
• Preferred investment style
If you’re looking for investments that are highly liquid and offer a modest rate of return with minimal risk, then you may turn to the money market. On the other hand, if you’re comfortable with a greater degree of risk in exchange for the possibility of earning higher returns, you might lean toward the capital market instead.
You could, of course, diversify by investing in both the money market and capital market. Doing so may allow you to balance higher-risk investments with lower ones while creating a portfolio mix that will attempt to produce the kind of returns you seek.
Alternatives to Money and Capital Markets
Aside from the money and capital markets, there are other places you can keep money that you don’t necessarily plan to spend right away. They include the different types of deposit accounts you can open at banks and credit unions. Specifically, you may opt to keep some of your savings in a certificate of deposit account, high-yield checking account, or traditional savings account. Here’s a closer look:
High-Yield Checking Accounts
Checking accounts are designed to hold money that you plan to use to pay bills or make purchases. Most checking accounts don’t pay interest but there are a handful of high-yield checking accounts that do.
With these accounts, you can earn interest on your checking balance. The interest rate and APY (annual percentage yield) you earn can vary by bank. Some banks also offer rewards on purchases with high-yield checking accounts. When looking for an interest-checking account, be sure to consider any fees you might pay or minimum balance requirements you’ll need to meet.
Traditional Savings Accounts
A savings account can be another secure place to keep your money and earn interest as part of the bargain. The different types of savings accounts include regular savings accounts offered at banks, credit union savings accounts, and high-yield savings accounts from online banks.
Of those options, an online savings account typically has the highest interest rates and the lowest fees. The trade-off is that you won’t have branch banking access, which may or may not matter to you.
The Takeaway
There are lots of reasons why people do not invest their money. A lack of understanding about the difference between money market vs. capital market investments can be one of them. Once you understand that the money market typically involves short-term, lower-risk debt instruments, while the capital market likely revolves around longer-term ones with higher risk and reward, you will be on your way to better knowing how the global financial market works.
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FAQ
What are the similarities between a money market and capital market?
Both the money market and the capital market are intended to make it easier for businesses and companies to gain access to capital. The main differences between money markets and capital markets are liquidity, duration, and the types of financial instruments that are traded. Both also represent ways that consumers can potentially grow their money by investing.
How is a money market and capital market interrelated?
The capital market and the money market are both part of the larger financial market. The money market works to ensure that businesses are able to reach their near-term credit needs while the capital market helps companies raise capital over longer time frames.
Why do businesses use the money markets?
Businesses use the money market to satisfy short-term credit and capital needs. Short-term debt instruments can be traded in the money market to provide businesses with funding temporarily as well as to maintain liquid cash flow.
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