How to invest in the money market

Not all money market instruments are substitutes for each other. Below we look at the various securities available for investing your cash in, and identify which ones we have preferences for.

MoneyMarketAs our masthead says, the Money Reporter is a newsletter for investors whose interest is more interest. To us, this motto means more than just helping you to maximize your equity dividends and distributions and the interest on your bond holdings. It means maximizing returns from your cash investments as well.

But it also follows that there are some money market instruments that we favour, and others that we prefer not to recommend. Let’s we sort out the list of money market instruments that we like, and those we don’t.

Money market instruments we like

First, we like treasury bills, both those issued by the Bank of Canada and those issued by the provinces. As for provincial t-bills, there’s so little risk, and higher incremental returns, that it makes them interesting alternatives to the Canada offerings.

Often, though, treasury bills don’t pay very much, and so we often prefer term deposits, especially from the non-bank providers. That, of course, is only if they have sufficient deposit insurance coverage, such as that offered by the Canada Deposit Insurance Corporation.

We also like cashable guaranteed investment certificates, under the same circumstances. But these days, you can find high-interest savings accounts offered by smaller institutions that pay higher rates than term deposits and cashable GICs.

We also like banker’s acceptances. Many investors don’t realize that BAs are not issued by banks; they’re issued by major corporations, and only guaranteed by the accepting bank. Even though the risk is the bank’s at that point, BAs often provide a better return than the bank’s own offerings.

What are banker’s acceptances?

If you invest some of your cash holdings into a money market instrument called a banker’s acceptance, what exactly is it you’re buying? Here are the essential facts.

A banker’s acceptance is a money market instrument issued by a corporation, issued at a discount to mature at par, with a maturity date from several days up to one year.

As an example, suppose a major blue-chip company needs to raise $80 million for 95 days. The company surveys various investment dealers and finds that the interest rate it faces paying is a little too high when the only security it offers is just its own good name and credit reputation. The company decides to attach a major bank’s guarantee of repayment to the issue.

The corporation proposes to its bank that the bank guarantee repayment of the issue in the event the corporation defaults, in exchange for a fee. The bank knowing the corporation has every ability to repay the issue, agrees, accepts the fee, and provides the guarantee. What was a commercial paper issue up to that point is now a banker’s acceptance.

The bank wins by getting a fee for a low-risk guarantee. The company wins because investors are now willing to accept a lower interest rate on the paper because it is now less risky.

What we don’t like so much

One instrument we don’t prefer is money market mutual funds. Returns are low enough to begin with that we don’t need to pay a management expense fee as well. And, as events just prior to the financial crisis have shown, money market funds can be risky, as they sometimes buy up mortgage derivatives, commercial paper and other things their investors don’t realize until too late are in these funds.

We tend to stay away from the big-bank offerings of term deposits and GICs. In fact, when we survey GIC rates across the country every two weeks, the big banks are almost never in the top three in terms of returns. It appears they rely on their name recognition, and your not shopping around, to get your business. By all means, check with your main financial institution as well as our rate table when you need a GIC, but our survey’s rates will probably be higher.   

This is an edited version of an article that was originally published for subscribers in the March 16, 2018, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

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