What Are Money Market Accounts?
A Quick Overview of How Money Market Accounts Work
When you hear about money markets, you need to differentiate between two different types of cash equivalents, money market accounts and money market mutual funds. Though they might sound and look the same, they are structured very differently from each other. Here's a breakdown to help you remember what distinguishes each:
Money Market Account
This is an FDIC insured type of account you open at a bank. It was originally developed decades ago to allow banks to compete with financial products coming out of Wall Street and serves as an alternative to certificates of deposit by providing greater liquidity. Most of the time, you'll be permitted a set number of withdrawals per month or quarter. Typically, customers who deposit $100,000 or more will get considerably higher yields.
Money Market Mutual Fund
Also called money market funds, these are mutual funds that seek to keep the net asset value of each share at exactly $1.00. The fund invests in things like U.S. Treasury bills or other fixed income securities. They are often put together by asset management companies that offer them through stockbrokers and other financial institutions. Money market funds can specialize in specific types of assets, such as only buying tax-free municipal bonds from a certain state so residents of that state get to enjoy the interest income without paying Federal or state tax. It isn't unusual for access to the better, higher-yielding money market funds to require minimum investments of $1,000,000 or more.
From a strictly technical standpoint, a money market account is safer as the balance, up to the limit, is backed by the United States Government, provided you are a customer of an insured bank. It is theoretically possible for a money market mutual fund to fall below $1.00 in net asset value, or "break the buck" as it is known. In almost all cases, the fund manager has stepped in and reimbursed the fund out of its own pocket to keep investors from panicking but it has no obligation to do this. There are risks, rare as they may be; risks that you, as an investor, should study prior to parking your cash. In actuality, few investors pay attention to this distinction (much to their panic when that once-in-fifty-year even happens). Both are traditionally used to keep things like down payment money secure until it is needed.
If you want alternatives to either of these cash equivalents, you might consider everything from short-term bond funds to plain vanilla savings accounts. Alternatively, many of the assets appropriate for a capital preservation mandate will fit the bill.
Yields on money market accounts and money market funds can differ wildly from institution to institution so it pays to shop around when you are looking to park cash. Sometimes, online banks or brokers will run specials to attract new deposits.