Money Market Fund vs. Savings Account: An Overview
If you don't have $1,000 or more moldering away in a savings account, this article may not interest you. If you do have that kind of cash saved, you may be wondering if a savings account is the best place to keep it. Sure, it's liquid, but the interest rates are only slightly better than those offered by your sock drawer and maybe only slightly better than the inflation rate. One alternative is a money market fund.
- Savings accounts are backed by the Federal Deposit Insurance Corporation (FDIC), while money market mutual funds have no such guarantee.
- Both have their own respective fees, but money market funds tend to offer higher returns, while they both have high liquidity and accessibility.
- When picking a money market mutual fund it’s best to focus on ones with low operating costs.
The big draw for a savings account is that it’s via a bank. The main reason people use banks to hold their money isn't because of lucrative returns from interest rates since those have long evaporated. Rather, it's because the bricks, sensors, and a tempered steel safe convey a sense of security that a sock drawer can't match. On top of the physical security of a bank, there is the protection provided by the U.S. government. The Federal Deposit Insurance Corporation (FDIC) guarantees the bank will not lose your money. The limit for this coverage is $250,000 per account and per owner.
Money Market Fund
Money market funds have no FDIC protection or backing from the federal government, and no guarantee of returns. However, the SEC carefully regulates money market funds, which generally only invest in financially reliable securities, with all investments required to have an average maturity of fewer than 120 days. This results in such funds investing in a lot of government issues (municipal, state, federal), which are the safest debt instruments. They have a lower yield than the market on average, but a better rate than your savings account.
Two potential financial burdens to savings accounts are their fees for transactions and for keeping the account open. However, maintaining a certain minimum balance or keeping withdrawals to a monthly minimum, or both, usually allows you to avoid these charges.
There may be balance requirements or transaction fees with money market mutual funds, too, along with minimum initial investment, which typically ranges from $500 to $5,000. There are also fees that bank accounts do not incur, the biggest of which is the expense ratio, which is a percentage fee charged on the fund for management expenses. For money market funds, these fees are typically very low, however; usually below 0.5%.
A savings account might earn you anywhere from a 0.1% to 1.7% annual return on your investment. The returns on money market funds range between 1% and 3%. This doesn't mean you'll necessarily earn 3% returns, only that the likelihood of doing so is higher than with a savings account.
As with bonds, the performance of money market funds is closely tied to the interest rates set by the Federal Reserve. When rates in the market are at very low levels, as they were from 2002 to 2004 and 2007 to 2009, these types of funds tend to generate returns on the lower end of the range, not much more than a savings account. So be aware of the current interest rate environment and how it compares to your savings account rate before you move your money to a money market fund.
Money market funds are comparable to savings accounts as far as liquidity goes. There is usually free check-writing, automated electronic exchange services, and telephone exchange and redemption. If you are sure the money will be sitting idle for more than three months, Treasury bills or CDs are a guaranteed option, but they come with penalties and fees for early redemption. Both a money market account and a savings account are for people who need access to the money.
There is a range of funds to help you relieve the different types of tax burdens. If you find yourself in a high state tax bracket but a low federal tax bracket, you can invest in a U.S. Treasury money market fund. There are also funds that are tax-free. The tax exemptions are based on what securities the fund invests in and whether they are local or federal debt issues. Tax-free in this case refers to the dividends—there is no tax deduction for the money you put into the funds. With some research, you should be able to find a fund that will meet your tax needs.
The various types of funds all invest in the same basket of securities within their section (municipal, Treasury, etc.), so the returns of a particular fund might vary a tenth of a percent from the others in its section.
A fund with low operating costs, therefore, will generally produce better yields. Annual operating expenses of 0.5% or less should be your measuring stick when sifting through the funds. If a fund company is successful, the larger amounts of capital it controls will translate into lower operating expenses for investors. Although these investments are considered low risk, in their attempt to outperform, some have reached for higher-yielding instruments outside the norm, including collateralized debt obligations (CDOs) backed by subprime mortgages.
The Bottom Line
Changing from a savings account to a money market account is more of a psychological leap than it is a change in actual mechanics. With a money market fund, you can still write checks and transfer money into your checking account when you need it, but it is no longer a savings account, it is an investment (albeit a short-term one).
The returns are better, the security is comparable, and taxes and access are easily handled. Despite this, people believe a savings account is somehow more solid. If you can get around that type of thinking, a money market mutual fund will help you to see some returns from the money you are keeping as an emergency fund or waiting to invest.