When idly browsing your bank’s website for fun (you do that, right?), you might see the phrase “money market account.” But what exactly is a money market account?
In short, you can think of it as a savings account on steroids—it's a type of bank account that requires more money to operate, but it has the potential to earn you more too.
Money market accounts (MMAs) may have a higher minimum balance or opening balance, and more restrictions on how you withdraw your money, says Tonya Oliver-Boston, Certified Financial Planner™ with LearnVest Planning Services. In exchange for jumping through these extra hoops, MMAs generally offer higher interest rates than regular savings accounts, meaning you're earning more money on your savings. Like other savings accounts, MMAs are available at banks and are subject to FDIC insurance (or protections for credit unions).
To help you maximize your dollars while avoiding potential pitfalls, we’ll first break down the difference between MMAs and the all-too-similar-sounding money-market funds, and once we're clear, help you figure out if a money-market account could be the right savings vehicle for you.
Money Market Account vs. Money Market Fund
As we just learned, a money market account (MMA) is basically just a high-interest savings account—but a money market fund isn’t a bank account at all. It’s actually a mutual fund you can get through your brokerage, and therefore lacks the FDIC protection afforded to bank accounts.
Money market funds are still seen as safe investment instruments because they invest in things like CDs and Treasury bills, which may have less risk than stocks and bonds. For that reason, you can think of money-market funds as a short-term place to park your investing cash in relative safety.
All the same, these funds are still riskier than money market accounts. Money market funds maintain a target share price around $1, so it may cause a panic if a fund should “break the buck,” or reprice its shares below a dollar. This has only happened twice in history—most recently in 2008 following the Lehman Brothers meltdown—but it shocked investors enough that the U.S. Treasury has mulled as-yet-unpassed new rules to make money market funds safer in the future.
“With a money market fund, there’s going to be more risk involved than with a money market account,” says Oliver-Boston, “and as a principle, the more risk you’re willing to take, the better the potential reward.”
Yields on money market funds aren’t always better than those of MMAs, though, despite the added risk. Before the financial crisis, money market funds were averaging a yield of 1.9%, and MMAs and savings accounts were averaging 0.7%. But by March 2012, the funds were earning less than MMAs, clocking in at 0.03% versus 0.14%. On top of that, money market funds charge operating fees, potentially negating your returns even further. Although, as long as you meet minimum requirements, MMAs are usually fee-free.
These days, the average yield for MMAs among the nation’s largest markets is 0.10%; some money market funds are earning a paltry 0.02%. If you’re looking for more serious returns than that, you’ll probably require riskier investments like mutual funds that invest in stocks and bonds.
After all, investors don’t typically invest in money market funds as an end-goal for their financial plan. “This is where your money is stored prior to investing,” Oliver-Boston says. When you open a brokerage account, a money market fund is where your money sits—earning relatively tiny returns—until you dispatch it to various other investments. “It’s usually seen as kind of temporary,” she explains.
Do You Need a Money Market Account?
An MMA may be good for “someone who has an emergency fund and is looking to keep it in a separate bucket that maximizes interest while keeping it insured,” says Oliver-Boston. MMAs often place limits on how often you can withdraw money, but that won’t matter if this is your emergency fund—and you don’t plan on having frequent emergencies.
By contrast, Oliver-Boston notes, “A money market account isn’t right for individuals who use savings as a backstop for their checking. If you find yourself dipping in to supplement your spending, then a regular savings account is probably better for you than an MMA.” Oliver-Boston recommends people have two savings buckets: One attached to your checking account so you can access it immediately if you need to, and another (potentially an MMA) where you can focus on maximizing your interest.
The distinction between MMAs and “regular” savings occur mostly at traditional, brick-and-mortar banks, but those aren't the only option—there are also online-only banks. Most online-only banks offer only one high-interest savings option, which is basically the same as an MMA, Oliver-Boston says. And in fact, many online banks will give you a high-interest savings account without a minimum balance.
Oliver-Boston offers one last word of caution: “Money market accounts and money market funds are not long-term investment solutions.” They are good vehicles for saving up money to prevent financial emergencies, but when talking about long-term wealth-building, she says, “these are not designed to meet those objectives.” Many people think putting money in an MMA or money market fund means “dipping their toes into more sophisticated savings strategies,” she says, “but when it comes to long-term investing like retirement or college savings, these instruments won’t get you what you need in terms of growth.”
LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc. that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment advice. Please consult a financial adviser for advice specific to your financial situation. The people quoted in this piece are not clients of LearnVest Planning Services. LearnVest Planning Services and any third parties listed in this message are separate and unaffiliated and are not responsible for each other’s products, services or policies.