By manybanking.com Staff
The term “money market” refers to the global financial market in which short-term investments are made. These investments include Treasury bills, commercial paper and other short-term financial instruments.
The money market consists mostly of banks borrowing and lending among themselves and it provides liquidity within the global financial system.
Often people misunderstand the concept of money market accounts because they focus on the “money market” part of the name. A money market account, also called money market deposit account, is essentially a savings account that allows you to write a limited amount of checks. This is a bank account, and funds are not directly tied to the money market.
Money market accounts typically offer higher interest rates than ordinary savings accounts. According to the manybanking.com survey, the current national average rate for a money market account is 0.53%, and it is only 0.26% for savings accounts. These accounts also carry more restrictions than savings accounts. Most money market accounts have minimum balance requirements of over $1,000. In some cases, the minimum is as much as $5,000 or $10,000. Transactions are typically limited to six per month, of which only three can be debit transactions.
The reason money market accounts are named as such is because of why banks can theoretically offer these higher rates. In theory, because they are heavily restricted, the funds in a money market account could be invested in the money market to produce higher returns. Some of those returns could then be passed onto the account holder as higher interest rates. Banks are not required, however, to actually invest the funds in a money market account into the money market. In addition, banks may use the funds in the money market account for lending and other purposes as well. For consumers, it’s irrelevant how the bank uses the funds, so long as the terms of the account are met.
Because of the similar name, money market accounts are sometimes confused with money market funds, also called money funds. The primary difference is that money market accounts are bank products and money funds are not. Consequently, money market accounts are protected up to $250,000 per depositor, per account type by FDIC insurance. Money funds are not subject to the same protection as they are a type of mutual fund that invests in the money market (low-risk securities). They produce similar returns to money market accounts, but do not carry a guaranteed return of principal.
A money market account is often used to park cash and works well as an emergency savings fund. Despite the restrictions, these accounts are highly liquid. Withdrawals can be easily made when needed and penalties are only assessed if the balance falls below the prescribed limit, or if more transactions are made in a month than the allowed amount.
As a long-term savings instrument, however, money market accounts can be beat in terms of interest rates by certificates of deposit (CDs) while maintaining the same FDIC insurance protection. According to manybanking.com, the national average 12-month CD rate is currently 1.45%. You give up some liquidity with a CD, but you earn more in interest to compensate. Be sure to browse money market rates at manybanking.com.
—For more ways to save, spend, invest and borrow, visit MainStreet.com.