5 Misconceptions About Money Market Accounts Explained

Key Takeaways

• Money market accounts are not the same as money market funds and are insured by the FDIC up to $250,000.
• Money market accounts offer both checking and savings features.
• Some accounts include check writing and debit cards.
• Monthly transactions often have restrictions.
• Inflation may reduce interest earnings over time.

A money market account offers features of both checking and savings accounts. Some money market accounts provide check writing and debit cards while paying interest. However, money markets often have restrictions and rules that limit monthly transactions. Federal Deposit Insurance Corp. (FDIC) coverage makes them a safe option for an interest-bearing account, but inflation potentially can outpace any interest earned, and FDIC insurance is capped at $250,000.

It’s important to distinguish money market accounts, which are deposit accounts held at a bank or credit union, from money market funds, which are mutual funds that invest in liquid assets.

Investopedia / Jessica Olah

What Are Money Market Accounts?

Money market accounts are deposit accounts held at banks and credit unions. Often referred to as money market deposit accounts (MMDA), they offer features distinguishing them from other savings accounts.

FDIC Insured

Money market accounts can provide a safe haven to hold your money, allowing you to earn interest and avoid the market volatility associated with investing. Just like saving and checking accounts, the Federal Deposit Insurance Corporation (FDIC) insures money market accounts up to $250,000.

Checking Account Features

Many money market accounts come with check-writing ability and a debit card. Some banks limit the number of transactions within the account. Before April 2020, the Federal Reserve Bank limited money market withdrawals and transfers to six per statement cycle—usually monthly. However, the Fed removed the limit to help individuals during the Coronavirus pandemic, but some banks still impose their own limits.

Interest Bearing

Money market accounts are interest-bearing, which typically pay slightly more than traditional savings accounts. Some investors, instead, opt for the low-risk, stable interest offered by Treasury bonds (T-bonds), which can pay higher rates than savings accounts. Nonetheless, money market accounts can still provide a good savings vehicle during times of uncertainty.

Money Market Accounts vs. Money Market Funds

It’s important not to mistake a money market account for a money market fund since there are critical distinctions between the two financial instruments.

A money market fundis a mutual fund characterized by low-risk, low-return investments. Mutual funds represent a basket of investments in which investors pool their money to invest. Money market funds invest in very liquid assets such as cash and cash equivalent securities. They generally also invest in high-credit-rating debt-based securities that mature in the short term.

You can usually transfer money in and out of a money market fund with relative ease, and they don’t charge loads—or mutual fund administration fees. You may hear investors say “money market” and assume their money is secure. However, the FDIC does not insure money market funds since they are investment products.

Money market fund returns depend on various factors, including market interest rates. They can have different classifications, such as prime money funds, which invest in floating-rate debt and commercial paper of non-Treasury assets. Money market funds might also include Treasury funds, which invest in standard U.S. Treasury-issued debt like bills, bonds, and notes.

Misconceptions About Money Market Accounts and Inflation Protection

A common misconception is that holding money in a money market account safeguards you against inflation. However, that’s not necessarily true. Money market accounts are not designed to outpace inflation. Instead, it is simply to grow savings at a faster rate than traditional checking or savings accounts.

Let’s assume, for example, that inflation is lower than the 20-year historical average. Even in this situation, the interest rates banks pay on these accounts decrease as well, affecting the original intent of the account. So, while money market accounts offer a safe place for your money, they really don’t safeguard you from inflation.

Inefficiency Risks of Money Market Accounts

The changing rates of inflation can influence the efficacy of money market accounts. In short, having a high percentage of your capital in these accounts is inefficient.

Important

Some money market accounts require minimum account balances for the higher interest rate.

Building an emergency fund typically requires six to 12 months of living expenses that should be kept in cash in these types of accounts. Beyond that, not investing will mean missing potential earnings.

Value of Using Money Market Accounts For Savings

In many instances, we tend to believe that saving money is ideal, but investing it well can provide greater returns. Staying in a cash position for too long instead of investing can result in the loss of potential gains—called opportunity cost. High-yield returns on your money generally require diverse investments. However, be aware that buying market-based investments that the FDIC does not insure may result in losses.

The Value of Diversifying Beyond a Money Market Account

Diversification is one of the fundamental laws of investing. Cash is no different. If you insist on holding all your money in money market accounts, no single account should hold more than the FDIC-insured amount of $250,000. It is not uncommon to see families or estates with multiple bank accounts ensuring their money as much as possible.

Using this strategy, dividing the money up into three “buckets” can prove useful. Having money set aside for the short-term (one to three years), the mid-term (four to 10 years and the long-term (10 years plus) can lead investors down a more logical approach to how long—and how much—money has to be saved. To take a more tactical approach, we can apply the same buckets and assess your tolerance for risk in a realistic way.

Consider putting long-term money into other low-risk investment vehicles like an annuity, life insurance policy, bonds, or Treasury bonds. There are countless options to divide your net worth to hedge the risk of losing the value of your money in cash.

These approaches help outpace current and future inflation while protecting money from losing its value. Understanding how different investment types work, including the risks and potential rewards, will allow you to make the right decision for your situation.

What Is a Money Market Account?

A money market account is a deposit account offering higher interest than traditional checking or savings accounts. Both banks and credit unions offer market accounts.

What Is the Downside of a Money Market Account?

The one possible downside of a money market account is that the institution may limit how many withdrawals you can make at a time, usually within a month or year, thus limiting access to your funds.

Is a Money Market Account Worth Having?

Whether or not a money market account is worth having will depend on the individual. However, a money market account can offer you a low-risk savings vehicle with a higher interest rate than a standard savings account. Also, the FDIC insures money market accounts, providing safety while helping you achieve your savings goals.

The Bottom Line

Money market accounts are like savings accounts in that they pay interest while keeping your money safe and liquid. They also share traits of checking accounts by allowing account holders to write checks on the account or draw from it with debit card transactions. Such transactions, however, often are capped at less than 10 per month, and the interest they pay should not be counted upon to counter inflation. If used as a place to keep cash easily accessible, they can be part of a diversified investment strategy.

Ultimately, you may want to research all your options and consult a financial advisor to determine the best way to use your cash to meet your financial goals.