Money Market Accounts, Money Markey Mutual Funds, and Certificates of Deposit

Many people confuse money market accounts, money market mutual funds, and certificates of deposit. Although all three are considered the safe investments, they are not the same thing. Carefully consider all three before choosing the one that is right for you. In this post, I define each.

Money Market Account

A money market account, also called an MMA or a money market deposit account, is a savings account. These accounts are offered by banks and credit unions, but they are also used as holding accounts by brokerages until you use the funds to buy securities. Money market accounts offer these features:

  • Slightly higher interest rate than savings or checking accounts
  • FDIC-insured to $100,000 (or similar private insurance)
  • Higher minimum balance than traditional checking or savings accounts (unless the account is part of a brokerage account)
  • Limited withdrawals (usually a maximum of six/month)
  • Limited check-writing privileges (usually a maximum of three/month)

In addition, if your account isn’t held at a bank or credit union, you may only be able to make deposits by mail, wire transfer, or electronic transfer.

Money market accounts are a safe place to keep savings, but also offer limited access. This might be good if you’re prone to nibbling away at your savings.

Money Market Fund

Money market funds, also called money market mutual funds, are fixed income investments sold in shares valued at $1. They are not savings vehicles. Money market funds invest in the cash market. In general, it means they buy very short-term debt securities, which banks, large corporations, and governments use to meet short-term cash needs. Short-term means maturities of less than thirteen months.

The amount of cash needed to invest in the cash market directly is so large that individuals can’t do it. Instead, money market funds pool the investments of thousands of people in order to buy these securities. They generally share the same features:

  • Average maturity of less than 90 days (required by the SEC)
  • Not FDIC protected
  • Low return
  • Low risk

When considering money market funds, you should also consider the expense ratio. As with any other mutual fund, the fund company charges expenses against the yield. An average is .28%. You should also review a prospectus before investing the money to make sure they choose investments you feel comfortable with. Each fund will hold a variety of short-term securities with different maturities, but the average maturity will be less than 90 days.

You can choose to invest in both taxable and tax-free money market funds.

Certificates of Deposit

Certificates of deposit are another very safe savings vehicle. They are also called time deposits, and are offered by banks, credit unions, and some brokerages. Maturity date range from three months to ten years. Each CD specifies an interest rate when you buy it. You can buy a CD in any amount, but most banks require a minimum. Banks also offer “Jumbo CDs” for deposits over $100,000. In general, higher deposits and longer terms receive higher interest rates. Most CDs share these features:

  • FDIC-insured up to $100,000 (or similar private insurance)
  • Steep penalty for withdrawal prior to maturity
  • Fixed interest rate during the term
  • Limited window to withdraw funds after maturity. If you don’t withdraw them, they roll into a new CD at the prevailing rate.

When considering a CD, first make sure that the bank insures its CDs. Next consider both the annual percentage rate and the annual percentage yield. The APR is the stated interest you will earn without compounding. The APY is the total interest you’ll earn with compounding. For example, a CD that pays interest once a year will have the same APR and APY, but a CD that pays interest quarterly will have a higher APY. The APY is the most important number to consider when comparing CDs.

CDs are good savings vehicles when interest rates are high and you expect them to fall. They’re also good if you can afford to have your money locked up for a fixed period of time. You can’t add to a CD, however, so they’re not good for incremental savings. They’re definitely not a place to keep emergency funds. They may be appropriate for college savings if your child will start college soon or is currently in school. Just make sure you choose maturity dates that will give you access to the money when the tuition bill arrives.

Choosing the Right Vehicle for You

When choosing between the three, consider three things:

  1. How soon you need the money
  2. Whether you’re willing to accept any risk
  3. The amount you hope to earn in interest

All three have benefits and drawbacks. Only you can decide whether a money market account, money market mutual fund, or CD is best for you.

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