There are many things you should consider when you make up your investment portfolio. You should know what your risk tolerance and investment strategy are, not to mention the kind of assets into which you plan to put your money. All of this depends on your goals—what you intend for the long-term like planning for your children's education and your retirement, but also your short-term goals.

You may find there comes a time when you need access to cash immediately—say for a medical emergency or if you want to take a vacation. Putting your money into an account that earns you interest but allows you to make withdrawals easily can help you realize these goals. You may want to consider putting some money into a savings account, or you can try a money market account (MMA), a liquid asset that provides a higher interest rate.

Key Takeaways

  • A money market account is a deposit account held at a bank, credit union, or other financial institution that pays interest and comes with check writing and debit card privileges.
  • MMAs are unlike other investments because they can be easily liquidated, unlike other investments.
  • Two factors limit money market account liquidity including minimum balance requirements and limitations to the number of monthly withdrawals.

Money Market Accounts

A money market account is a deposit account held at a bank, credit union, or other financial institution. This account pays interest—much higher than regular savings accounts. Banks use the money in a money market account to invest in short-term liquid assets including Treasury bills (T-bills) or municipal bonds. Banks earn interest on these investments and, in effect, split the interest with account holders.

Making a withdrawal from a money market account is as simple as any other deposit account. Many of them come with debit cards and other features including the ability to write checks. Account holders may also be able to visit their bank or credit union branch to make their withdrawals.

Although they may share some similarities to standard checking and savings accounts, they do come with certain restrictions, which makes them less flexible. They may come with minimum balance requirements, a limited number of withdrawals, and often come with fees and other charges.

Money Market Accounts and Liquidity

Money market accounts are not like other investments because they are highly liquid assets. Except for certain limits on the availability of recently deposited funds, money market account deposits are available for immediate withdrawal. This means these accounts can be quickly converted into cash without losing value. Money market accounts are nonterm deposits, so there is no maturity date. Account holders don't lose any interest when they liquidate their accounts. Term deposits, on the other hand, require the account holder to keep the account open until the maturity date. Early withdrawals usually result in the forfeiture of interest.

There are two factors that limit money market account liquidity. Unlike checking or savings accounts, banks require people who hold money market accounts to maintain a minimum balance—as much as $5,000 to $10,000 on the low side. And because it is a savings account, it must follow federal regulations. All account holders are limited to six withdrawals per month. Any additional debit transaction results in a service charge or transaction fee.

A money market account's liquidity may be limited by minimum balances and a limited number of withdrawals.

Deposit Base for Banks

Commercial banks and credit unions provide money market accounts to attract relatively large, stable deposits in exchange for interest rates that are slightly higher than those for savings accounts and interest-bearing checking accounts. This stable deposit base increases the financial institution's ability to make loans.

This need for stability gives rise to the only substantive liquidity limitations, which are the requirement to maintain certain balances and the limit on the number of withdrawals. Violating these balance requirements and transaction limits may reduce the interest earned on the deposits or increase the fees paid.

It is important to note that money market accounts, which are federally insured deposit accounts, are different from money market funds offered by investment banks.

Money Market Accounts vs. Money Market Funds

The fact that money market accounts are insured, and therefore regulated, by the Federal Deposit Insurance Corporation (FDIC) provides a regulatory and structural support for these accounts. Of course, the ability to recover loss through insurance is not a practical source of liquidity since such a recovery may take up to two business days. However, this federal insurance is an important, and often misunderstood, distinction between money market accounts and money market funds.

Money market funds are a type of mutual fund. They are somewhat similar to a money market account in that they are low-risk assets that also invest in short-term, highly liquid vehicles. But that's where the similarities end. Money market funds are offered by investment firms, which sell shares to investors in the fund. Investors can sell their shares if they need cash, and generally incur capital gains or losses that must be reported to the Internal Revenue Service (IRS). And unlike money market accounts, the principle in a money market fund is not guaranteed. Money market funds are regulated by the Securities and Exchange Commission (SEC), and aren't insured by the FDIC.