You may have heard of the money market. In this part of the financial market, investors trade assets that are generally low in risk, are highly liquid, and mature within a short period of time—usually within one year. This market is a great place to invest if you're looking for a place to store your cash for a short time frame, but may need to cash them out in case of an emergency. You can also use this type of account to hold funds during times of market volatility. No matter why you keep cash in a money market account or money market mutual fund, it is important to understand how the interest rate paid to the account is determined.

Key Takeaways

  • Because the money market is dependent on highly liquid assets, these investments are fairly safe and come with low risk.
  • These investments are also characterized with a fairly low interest rate compared to other investments.
  • Interest is generally calculated on a daily basis for money market accounts, and is paid out at the end of each month directly into the account.
  • Money market mutual funds are subject to lower interest rates because of the underlying assets, and because they are dependent on the applicable market interest rates.

Money Market Accounts

You can set aside funds in a deposit account with a bank or credit union known as a money market account. Some banks also call these money market deposit accounts. Although some may compare this to a conventional savings account, a money market deposit account does have some key differences.

Some accounts may allow investors to write checks or do transactions with a debit card. But because these accounts are meant to hold savings, the number of transactions is limited by federal guidelines to six per month. Additional debits usually incur a fee. Money market accounts may also come with minimum balance requirements. If this balance is not met, then the account holder is subject to a maintenance charge.

Money Market Mutual Funds

Similar to a money market account, a money market mutual fund provides a relatively low-risk setting for cash-equivalent liquid funds. Money market mutual funds are just like mutual funds in that investors buy and sell shares or units of a fund offered by an investment firm. Unlike money market accounts, these funds are not insured by the Federal Deposit Insurance Corporation (FDIC). Instead, they are subject to regulations set forth by the Securities and Exchange Commission (SEC).

Money market mutual funds invest in the same short-term securities as banks that offer deposit accounts, which may include commercial paper, Treasury securities, municipal bonds, and other highly-rated debt securities with a maturity date of less than one year.

Money Market Interest Rates

Because the money market is dependent on highly liquid assets, these investments are fairly safe and come with low risk. That means they are also characterized with a fairly low interest rate compared to other investments.

Because the underlying assets in money market investments are fairly low-risk, the interest they pay tends to be low as well.

Money Market Account Rates

Financial institutions have fewer restrictions on how they can invest the funds deposited into savings accounts. These rates are much lower because the money is lent out to other consumers in the form of loans and credit cards, which are much riskier investments.

Money market accounts, on the other hand, work a little differently. Banks invest deposited funds in short-term securities including certificates of deposit (CDs), municipal bonds, and Treasury notes (T-notes). This usually provides investors with higher interest rates than traditional savings accounts. Interest is generally calculated on a daily basis, and is paid out at the end of each month directly into the account.

Money Market Fund Rates

Unlike other mutual funds, money market mutual funds are subject to lower interest rates because of the underlying assets. These, as noted above, have much shorter maturity dates and much lower risk. Returns from these instruments are dependent on the applicable market interest rates, and therefore the overall returns from money market funds are also dependent on interest rates. So, the lower the rate set by the Fed, the lower the rate a money market fund pays to its investors.

The Bottom Line

Although the interest rate paid to a money market account may not be high relative to other investment options, both money market deposit accounts and money market mutual funds may provide more interest than a conventional savings account due to the underlying securities managed by the bank or mutual fund company.