Are you torn between a money market account and a money market fund? Before deciding which is best, it’s worth understanding how they work, along with the pros and cons of each and how they compare to one another.
What Are Money Market Accounts?
A money market account is an interest-bearing deposit account offered by banks and credit unions. A key feature of money market accounts is the ability to write checks or use a debit card for withdrawals. This makes them more flexible than some other savings options. However, financial institutions usually limit the number of transactions you can make each month.
Money market accounts are often considered safe. They are typically insured by the Federal Deposit Insurance Corporation (FDIC) for banks or the National Credit Union Administration (NCUA) for credit unions. This means your money is protected up to certain limits if the financial institution fails.
What Are Money Market Funds?
Money market funds are a type of mutual fund that invests in short-term, high-quality debt securities, cash and cash equivalents. These funds are often used by investors seeking a safe place to park their money with a modest return. Most are available through brokerage funds and offer both liquidity and easy access to your funds, although they are not federally insured.
Unlike other investment vehicles, money market funds strive to maintain a stable net asset value (NAV) of around $1 per share.
Money Market Account vs. Money Market Fund: Comparison
Pros and Cons of Money Market Accounts
Pros:
- Federally insured: Money market accounts are a safe place to park your funds, and up to $250,00 of our balance is backed by the FDIC or NCUA in the event of a bank closure.
- Generous APYs: The interest rates are typically higher than regular savings accounts, which makes money market accounts an attractive option if you want to maximize your earning potential without putting your hard-earned money at risk.
- Flexibility: As previously stated, many money market accounts come with debit card access and check-writing privileges for added convenience and flexibility.
Cons:
- Minimum balance requirements: Money market accounts often require account holders to carry a minimum balance or risk incurring monthly maintenance fees.
- Inflation risk: Interest rates on money market accounts might not always keep pace with inflation.
- Transaction limits: Banks and credit unions often restrict the number of checks or withdrawals allowed, which can be problematic if you need frequent access to our funds.
Pros and Cons of Money Market Funds
Pros:
- Earning potential: Money market funds aim to offer higher returns on your savings than money market accounts and traditional savings accounts.
- Low-risk: They are generally short-term, low-risk financial instruments that are designed to keep your investment safe and help it grow over time.
Cons:
- Not federally insured: While these funds generally provide liquidity, FDIC and NCUA coverage does not extend to them to provide that added layer of protection and peace of mind.
- Market impacts: The returns on money market funds are determined by interest rate changes from your financial institution and market conditions.
Interest Rates and Returns
Yield from Money Market Accounts
Money market accounts often offer higher interest rates compared to regular savings accounts. You might find MMAs with annual percentage yields (APYs) higher than 5%, depending on the bank or credit union you choose.
Yield from Money Market Funds
Money market funds provide higher returns in a high-interest rate environment driven by Federal Reserve policies. However, these yields are variable and can change with market conditions. Potential returns from money market funds are usually in line with, or slightly lower than, high-yield savings accounts.
Risk and Safety
FDIC Insurance Coverage on Money Market Accounts
Again, money market accounts are considered quite safe for depositors due to FDIC of NCUA insurance coverage. This coverage ensures that your money is protected up to $250,000 per depositor, bank or credit union if the financial institution fails.
Risk Levels of Money Market Funds
Money market funds operate differently, offering a low-risk investment option but without the same federal backing. These funds invest in high-quality short-term securities like government bonds and commercial paper, which are considered safer investments.
However, unlike money market accounts, they are not insured by the FDIC. And while they aim to maintain a stable net asset value (NAV), changes in interest rates can affect their returns.
Historical Performance and Security
Both types of accounts have performed well over time. More specifically, they have provided stable, consistent returns to account holders and investors.
Access to Funds
Liquidity Features in Money Market Accounts
Money market accounts are known for their liquidity, as you can typically pull cash or make purchases using a debit card or write checks directly against the account. That said, as previously mentioned, you could be subject to transaction limits.
Liquidity and Redemption of Money Market Funds
Money market funds are relatively liquid, but they don’t provide instant access to your cash when you need it like a money market account would. Instead, you’re required to redeem shares in exchange for funds – a process that could take up to two business days to complete.
Withdrawal Restrictions
Again, you can expect withdrawal restrictions with money market accounts. The specifics depend on the financial institution you choose, but most cap transactions at six per month before monetary fees apply. Or, the bank or credit union could convert your money market account into a standard checking account if you frequently exceed these limits.
Money market funds require the sale of shares to access money. While this may not have the same withdrawal frequency limits, you could face other constraints like minimum balance requirements or fees, which affect your ability to withdraw funds as needed.
Fees and Charges
Common Fees for Money Market Accounts
It’s common for money market accounts to come with account maintenance fees. The upside is you can typically have them waived by meeting certain criteria every month, like keeping the balance at or above a certain level.
Excessive withdrawal fees are also standard with money market accounts. As previously mentioned, failing to adhere to your bank or credit union’s guidelines could mean more out-of-pocket costs.
Overdraft fees are another expense to consider. You can avoid them, though, by being vigilant about your account activity, keeping your spending in check, and opting for overdraft protection if it’s available.
Expense Ratios and Fees for Money Market Funds
Money market funds typically have what’s known as an expense ratio. This fee is a percentage of your investment and covers the cost of managing the fund. The amount you’ll pay depends on the type of money market fund and the management company.
The fee is usually on the lower end but could place a dent in your overall returns. Keep in mind that account maintenance and management fees may also apply.
Investment Minimums
Minimum Balance Requirements for Money Market Accounts
Money market accounts usually require you to maintain a minimum balance to avoid fees. This amount can vary widely depending on the financial institution.
Some banks might set this at $1,000, while others may demand up to $10,000. If your balance falls below the minimum, you could incur monthly fees that generally range from $5 to $25, which may seem like a small price to pay but could add up over time.
Minimum Investment Amounts for Money Market Funds
Money market funds typically have different minimum investment requirements than money market accounts. The initial investment can range from $500 to $3,000 or more, depending on the fund’s policies.
It’s worth noting that smaller investment firms tend to have lower minimums. Some funds may have additional requirements for subsequent investments.
Tax Implications
Tax Treatment of Money Market Account Interest
The interest earned on money market accounts is a form of taxable income. So, it must be reported on your Form 1040 when you file your federal tax return. You’ll receive a Form 1099-INT by the end of each January that details your interest earnings and the amount to include on your return. But if you don’t receive it, be sure to reach out to your financial institution to request a duplicate copy.
Tax Considerations for Money Market Fund Dividends
Dividends from money market funds also have tax implications. These are generally treated like ordinary income, which is taxed at your regular income tax rates.
When interest rates rise, as seen recently, higher yields may result in more taxable income. Some money market funds involve taxable repo agreements, which can affect your after-tax returns, especially in high-tax states.
Alternatively, short-term treasury-based funds might be appealing because they often provide tax-exempt income.
Suitability for Different Investors
Money Market Accounts for Conservative Savers
If you prioritize security and stability and want to keep your savings safe, a money market account is ideal for you. To recap, they provide the best of both checking and savings accounts since you generally get the luxury of earning a higher interest rate along with a debit card for everyday use.
Most also come with check-writing privileges, making it even easier to access your funds if the need arises. Plus, these accounts are typically backed by the FDIC or NCUA for added protection and peace of mind.
Money Market Funds for Investors Seeking Higher Yield
If you’re open to taking on more risk for the potential of higher returns, consider a money market fund. Unlike money market accounts, they aren’t insured by the FDIC, meaning there’s a chance of losing your initial investment. Still, the ability to earn higher yields could make them well worth it, particularly if you’re open to taking some risk. Plus, they are an ideal option if you want to diversify your portfolio of assets while you work to build up your savings and create long-term wealth.
Conclusion: How to Choose Which One is Right for You
It comes down to your unique needs and personal preferences. Money market accounts work for the more conservative investor, while money market funds are better suited for those seeking higher yields who are willing to assume some risk in return.
