Savings are one of the most crucial factors in effective financial planning. However, investing the saved amount is ideal for building wealth over time. When individuals think of investing, they face the basic dilemma of choosing between money and stock markets.
This blog will explain one of the share market basics, namely, the money market vs. the stock market, so you can make informed investing decisions.
Money markets
The first factor in understanding the money market vs stock market concept is learning about the money market. The money market in India is a marketplace for highly liquid securities that can be immediately turned into cash. It allows for the constant flow of cash between governments, banks, NBFCs, corporations, and financial institutions.
Money market investments are short-term investments that generally have a maturity rate of less than one year. They allow issuers to borrow money from investors for their short-term needs without having to attain a high-interest loan. Furthermore, businesses with extra cash also utilise money market instruments to park their money for steady returns.
Some examples of instruments available to buy in money markets are Treasury Bills (T-Bills), Commercial Paper (CP), Certificates of Deposit (CDs), and Repurchase Agreements. All the money market instruments come with a coupon rate (interest rate), which the issuer agrees to pay along with the principal amount of repayment at maturity.
About liquidity
Governments, banks, and companies with debt obligations need money regularly to ensure they don’t fall short. For example, if a bank is having a temporary cash-flow problem and needs money to pay interest to its FD holders, it may need liquidity (assets that can be turned to cash quickly).
Money market instruments allow such entities to maintain high liquidity as the included instruments are short-term and highly liquid. Hence, they do not have to avail of an expensive loan to have the needed liquidity to complete their debt obligations.
Furthermore, it also provides liquidity to individual investors who want to invest in short-term assets that they can sell quickly to realise cash. They can also invest in mutual funds that invest in money market instruments to have high liquidity as mutual funds see high trading volume.
Stock market
The next factor in understanding the difference between stock market and money market is learning what is share market. The share market or stock market is a marketplace where shares of different companies trade, and investors can buy and sell them on stock exchanges such as NSE and BSE. Whoever buys the shares of a company becomes the company’s shareholder and part-owner. Stocks trading on the stock exchanges have no maturity date and exist until the company’s merger or bankruptcy.
Unlike money market instruments, companies that offer their stocks for sale have no obligation to pay interest or return the principal amount. However, some companies pay regular dividends (a portion of company profits) as a reward for holding the shares. The main goal of companies to enter the stock market is to sell their shares to raise funds for business purposes.
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Primary and secondary markets
Now that you have a basic understanding of the stock market under the money market and stock market difference, it is important to further understand stock market types. The stock market is divided into two markets: primary and secondary.
The primary stock market is a marketplace where companies issue their shares for the first time. For example, if a company launches an IPO to sell its shares for the first time, it does so in the primary market. Investors apply to the IPO issue and are allotted shares.
On the other hand, the secondary market is a marketplace where investors can sell or buy shares that were issued in the primary market. For example, investors can sell their IPO-allotted shares after they are listed on the stock exchange, and new investors can buy them. This trading of shares happens on the secondary market after the company becomes a publicly listed company.
Differences between money market and share market
Here are the major money market and stock market differences:
- Purpose: The money market helps issuers cover working capital requirements, while the stock market helps companies fund long-term business purposes.
- Function: The money market offers short-term liquidity to the economy, while the share market provides a way for strategic capital appreciation and earnings.
- Nature: The money market is an informal market without high levels of regulations, while the share market is formal as it is highly regulated by SEBI.
- Mode of transaction: The mode of transaction in the money market is over-the-counter, while in the share market, transactions happen through stock exchanges.
- Liquidity: Instruments in the money market are more liquid than stocks.
Appropriate usage
The money market vs stock market debate also includes their appropriate usage. Money market instruments are ideal if you are looking for highly liquid securities that can offer you regular interest along with principal protection. However, you can invest in stocks if you want to earn profits through capital appreciation or steady income from dividends and have a higher risk tolerance. Furthermore, you can choose money market instruments if you want to invest for a short period and stocks if you want to invest for the long term.
Considerations
While choosing between the money market and the stock market based on the money market and stock market differences, it is vital to consider some factors. Tax implications are one such consideration. Earrings from money market instruments are taxed as regular income and as per the income tax slabs. On the other hand, profits from the stock market are taxed at 10% if the holding period is less than 1 year and at 15% if the holding period is above 1 year.
The bottom line
The money market and the share market both offer ways to earn a return on investments. However, the money market is considered less risky as it offers guaranteed interest payments and principal repayment, while the stock market has better potential for profits. Hence, it is important to understand the difference between stock market and money market before you choose where to invest your money.
