MONEY MARKET ACCOUNTS

Overview

Money market accounts and funds give you easy access to your money, but with a higher rate of return than traditional checking and savings accounts. For that reason, they are ideal places to keep money that you are saving for an emergency, money you plan to need in the short-term, or money that you are planning to invest at a later date.

You can open a money market accounts through banks, brokerage firms, and mutual fund companies.

Types of Money Market Accounts

Money market accounts may be offered through three sources:

• banks
• brokers
• investment companies

Banks: money market deposit accounts

At many financial institutions, savings accounts have given way to money market deposit accounts. The money market deposit account through your bank gives you ready access to your money and pays a higher interest rate than traditional savings accounts. You may find that you’ll receive a higher rate of interest if you deposit a larger amount.

Brokers: cash management accounts

When you’re ready to buy and sell stocks, you will need to open a brokerage account. You set up an account with a brokerage firm, which is also known as a broker-dealer. Typically, you will set up a cash management account to pay for your investments and to stash the proceeds from any you’ve sold.

Brokerage firms offer cash management accounts that earn money market interest rates. The cash management account has a number of benefits:

• You can keep your savings there and earn competitive interest rates.
• You can use it as a brokerage account to buy and sell investments through that firm.
• You are often entitled to checking account privileges, a debit card and a line of credit.

You might pay high fees to maintain a cash management account at a brokerage firm. These fees are sometimes waived if your account is large or you meet other criteria established by the broker-dealer.

Investment Companies: money market mutual funds
         
Just as you and your friends throw your money in a pot to buy pizza, mutual funds pool the investments of thousands of investors. Each mutual fund has a manager or a team that invests your money in accordance with the fund’s objectives.

Almost all money market mutual funds have these features:

• They invest short-term in extremely safe investments.
• Your rate of return fluctuates as interest rates go up and down
• Your principal is extremely safe, though it is not guaranteed by the FDIC
• You have ready access to your funds.

Money market funds are viewed as a cash equivalent investment. In other words, the value of each share stays at $1 and does not go up or down as it might with other kinds of mutual funds.

What are the differences?

With every kind of money market account, the interest rate you receive is based in part on how high or how low interest rates are. The interest rate on brokerage cash management accounts and money market mutual funds is likely to change slightly each day as new investments are bought and sold. The money market deposit account through your bank usually offers a specified interest rate for a defined period of time. For example, the interest rate through your bank may only be guaranteed for the next 90 days.

The biggest difference between a money market deposit account through your bank and one through a broker or mutual fund company is safety. The money market account through your bank is protected by the FDIC, unless you have more than $100,000 in that financial institution. Nevertheless, brokerage cash management accounts and money market mutual funds are almost as safe. The Securities Investor Protection Corporation (SIPC) protects you if the brokerage firm holding your money goes out of business. The SIPC is not, however, the equivalent of the FDIC and does not protect you if your investment goes down in value.

Tips & Common Mistakes

Tip: Be aware of fees & expenses

As you decide which type of money market account is right for you, if any, look at the potential fees and expenses that can eat away at your investment:

• Penalties for falling below the minimum balance requirement
• Fees for writing too many checks
• New account fees

If you invest in a money market mutual fund, look for one with low annual expenses that won’t drag down your rate of return.

Tip: Be aware of the minimum investment amount

Every type of money market account requires a minimum investment, which is likely to be much higher than with a typical checking account. Your account might be closed if you fall below this established minimum. Furthermore, the money market deposit account through your bank is likely to pay higher interest rates as you deposit more money.

Tip: Lock in high interest rates by investing in CDs, instead

Money market accounts and funds are viewed as less risky than many other investments. If you want to lock in a high rate of interest, though, you might be better off with a Certificate of Deposit (CD) or a security you buy directly from the U.S. Treasury.

Tip: Write checks on your money market account

If you only write a few checks per month, you might be able to utilize a money market account or fund as a checking account. However, some accounts and funds require that the check be above a certain amount.

Common mistake: Viewing a money market account as a long-term investment

Your typical money market investment pays a higher interest rate than a savings account. However, as with a savings account, it should generally not be viewed as a long-term investment.

Common mistake: Getting a promotional rate

Make sure the interest rate isn’t a come-on to attract new customers. If it is, you may find it will drop after a few months.

Getting Started

You should consider a money market investment if:

• You need a place to keep your emergency fund.
• You’re putting money aside that you’ll need soon.
• You’re building an account to invest at a later date.

Here is a checklist you can use before launching into a money market account:

1. Compare the interest rates on the various types of money market investments.
2. Analyze the potential fees you may be required to pay.
3. Make sure the money market investment offers the features you need, such as the ability to write a certain number of checks each month.
4. Find out what the minimum balance requirement is and the consequences of going below it.
5. Ask questions and read the fine print in the literature that describes your investment.

As you compare interest rates, remember that money market mutual funds report the interest over the past seven days and that figure doesn’t include compounding. After you make your decision, you can enroll online, in-person, or by phone.

FAQs

Am I better off with a money market deposit account through a bank, a cash management account or a money market mutual fund?

If you want absolute safety, a money market deposit account is probably your best investment. Although cash management accounts and money market mutual funds are not insured by the FDIC, they offer extremely high levels of safety. In fact, they often put much of their money in investments guaranteed by the government. Therefore, instead of making your decision based on safety, you should look at which account or fund meets your other needs.

If you’re just getting started, you might choose the account or fund with the lowest minimum balance to qualify for the highest interest rate. Some financial institutions are willing to waive the minimum balance if you agree to invest a small amount automatically each month.