Money Market Accounts and Mutual Funds

Part 1: What They Are

Money market accounts (MMAs) are bank savings accounts that generally pay a higher rate of return than regular savings accounts. They’re insured by the Federal Deposit Insurance Corporation (FDIC) for up to $100,000 ($200,000 for joint accounts) per financial institution. In exchange for the higher interest rate, you have somewhat limited access to your money with this type of account. Withdrawals are usually limited to around six per month, and you can only write three checks without incurring additional withdrawal charges. Minimum balance requirements for MMAs are generally also higher than standard savings accounts, ranging anywhere from $500 to $2,500 or more. Many banks will also link an MMA to your checking account, allowing you to use it as a type of overdraft protection. If you write a check for a total that’s larger than what you have available in your checking account, an amount necessary to cover the deficit is automatically transferred over from the MMA to pay it.

The rates of interest offered on MMAs vary from one bank to the next and not necessarily because of fluctuations in short-term interest rates by the Federal Reserve. Financial institutions compete with each other vigorously in an effort to lure new deposits. Therefore, the only way to find the best rates offered is to shop around and compare diligently. The difference between the highest- and lowest-paying programs can be quite substantial.

Unlike MMAs (which, as stated, are savings accounts), money market mutual funds are mutual funds that invest in the shortest-term, lowest-risk, most highly rated debt securities available. These securities include Treasury bills, Certificates of Deposit (CDs) and municipal bonds. Money market funds are regulated by the Securities and Exchange Commission (SEC). Because the SEC doesn’t like to see a lot of fluctuation in the safe-haven bond- and CD markets, they require money market funds to keep the average maturity of their portfolios under ninety days. Doing so keeps them safe from the risks that changes in short-term interest rates could pose. Investors also receive the safety of diversification because these funds are actually pools of securities. Share prices remain constant at $1.00 per share. As your money grows, gains are realized in terms of additional shares, not as an increase of individual share prices. Although money market funds aren’t insured by the FDIC, they are considered to be an extremely safe investment.

Money market fund accounts are typically opened through a brokerage firm, although some banks do offer them. Most funds keep their minimum investment requirements low. Some set them at zero; others require an initial deposit of $500 but afterwards let you buy additional shares in small amounts. Each day, any accrued dividends are credited to your account in the form of additional shares or pieces of shares. If you need to withdraw funds, you have immediate access to do so by mail, phone, check or electronic transfer, with no penalties for early withdrawal. Although they don’t limit the number of withdrawals or checks that you can make, some funds will only allow checks for an amount above a prescribed minimum. Others may charge a per check fee if you don’t keep a certain balance in your account. Make sure that any fund that you choose doesn’t have restrictions that are too unreasonable or expensive.

In Part 2 of this series, we’ll take a look at the different types of money market mutual funds.

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