When it comes to saving money, there’s no greater ally than compound interest. Without it, it would be hard to grow your savings beyond inflation’s creeping grasp. That’s why the interest rates we get on our savings are so important.
While most people are aware of high-interest savings accounts, many are in the dark about this type of account’s higher-paying counterpart, money market accounts. In fact, many of the savings accounts banks market as high-yield accounts are, in fact, money market accounts.
No matter what the banks choose to call them, if you’re looking for a low risk, higher yield savings option, money market accounts are worth considering. So let’s take a look at how these accounts work, and what type of saver they’re most likely to work for.
Be sure to also read about the Pros and Cons of Compound Interest.
What Is a Money Market Account?
A money market account is a high-interest savings account, but it’s able to offer higher interest rates than other types of savings accounts by putting restrictions on depositors. These restrictions may include:
- A higher minimum deposit
Unlike typical savings accounts, which can be started with only a few dollars, a money market account usually requires a minimum deposit of at least $1,000.
- Minimum balance requirements
Most money market accounts require a minimum balance to remain in the account at all times. If the account dips below that minimum, the depositor may incur additional fees.
- A limit on the number of withdrawals allowed per month
Most money market accounts limit withdrawals to around five per month. Additional withdrawals will be subject to a penalty fee.
- Limited check-writing privileges
Some money market accounts allow depositors to write a few checks from the account per month.
These limits and restrictions ensure that a depositior leaves more cash in the account for longer, allowing the bank to lend it out to other customers. This is how money market accounts are able to offer higher interest rates.
Who Should Use a Money Market Account?
A money market account is less liquid than a typical savings account, but more liquid than a certificate of deposit. It provides a low-risk savings option with just enough liquidity for major purchases or emergencies. For many people, this setup has an additional benefit: It provides some incentive to leave those savings in the bank.
Learn more about Certificates of Deposit.
Like any bank deposit, money market funds are also insured by the Federal Deposit Insurance Corporation (FDIC) (or, in the case of a credit union, by the National Credit Union Administration (NCUA)), which means that if your bank goes out of business, you’ll still get your deposit back.
Be sure to also see our Guide to Credit Unions.
Because money market accounts tend to have higher interest rates than typical savings accounts and restrictions against too many withdrawals, they can be excellent for long-term savings. Some money market accounts even reward depositors by increasing the interest rate when the account breaks certain thresholds, such as $10,000.
Alternatives to Money Market Accounts
Investors can also gain exposure to money market rates through exchange-traded funds (ETFs). Whiles these instruments aren’t identical to a traditional money market account from your local bank, the premise behind them is generally similar with one advantage being their intraday liquidity; on the other hand, these are not FDIC insured and there is a small management fee associated with each of these products which ultimately takes a bite out of your bottom line returns.
The table below showcases four of the most popular money market ETFs:
iShares Barclays Short Treasury Bond Fund
PIMCO Enhanced Short Maturity Exchange-Traded Fund
SPDR Barclays Capital 1-3 Month T-Bill ETF
Guggenheim Enhanced Short Duration ETF
Pros and Cons
No investment is perfect. Like any financial instrument, money market accounts have both positive and negative characteristics. The key for investors is to choose the investments that best fit their needs. Money market accounts have the following key benefits:
- Higher interest rates than other savings accounts
- Some liquidity
- FDIC insurance
- An incentive to save
Money market accounts also have a few drawbacks. These include:
- Service and other fees for exceeding the allowed number of withdrawals, dipping below the minimum deposit or writing more than the allowed number of checks per month
- Limited liquidity
One other drawback to money market accounts that’s worth mentioning is that while they may carry higher interest rates than other savings accounts, we’re still talking about very low returns compared to other types of investments. For younger investors and those who are able to take on more risk in their portfolios, keeping large amounts of money in a money market or any other type of savings account may not be an appropriate investment strategy.
Be sure to also read the 21 Ways Investors Can Make and Keep More Money.
What a Money Market Account Is Not
One thing that’s important to mention when it comes to money market accounts is that they differ greatly from money market funds. Even though the names are similar and many investors think of them as interchangeable stashes for ready cash and emergency funds, money-market accounts and money-market funds are very different.
A money market fund isn’t a bank account, it’s a mutual fund. As a result, it doesn’t qualify for FDIC insurance, even if you buy it at your local bank. This type of mutual fund invests in short-term U.S. debt and other short-term obligations. The yields on these types of investments determine the returns on a money market fund.
To learn more about these securities, be sure to read the Beginner’s Guide to Money Market Mutual Funds.
Although money market funds are relatively low risk as far as mutual funds go, as with any market-based investment, they present a risk of loss to investors. That’s where they really differ from money market accounts, which are essentially risk free.
The Bottom Line
Money market accounts aren’t that different from other types of savings accounts except for a few additional restrictions. For those who are looking to save for the longer term and make limited withdrawals, they can be a great option for earning a little bit more interest. Interest rates, fees and restrictions can vary widely between banks and credit unions, so if you’re looking to make a deposit to a money market account, it’s up to you to find the one that’ll give you the best possible return.
And if a money market account isn’t the best fit for the way you’re using your savings, don’t sweat it. If you set up a consistent saving and investing plan you should be just fine.