The money market is a market in fixed-income securities. Like other fixed-income securities markets (the bond market, for example), the money market is a stable place to put your money but it’s not a get-rich quick plan. We’ll walk you through what it is and how it works. If you decide it’s for you, you can choose a money market account for your emergency fund.
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How the Money Market Works
Like bonds, money market securities are fixed-income securities that act as IOUs. The purchaser earns a modest amount of interest and the seller promises to return the principle (purchase price) of the money market security at a later date.
Money market securities are very liquid and they have short maturities. Examples include short-term certificates of deposit (CDs), US Treasury bills (T-bills), repurchase agreements (also known as “repos”) and commercial paper (short-term unsecured loans issued by companies that need to raise money).
What Is a Money Market Account?
Money market accounts come from banks and credit unions. They’re similar to savings accounts, but usually have a slightly higher rate of return. They also have limited check-writing, withdrawal and transfer allowances.
Like money in a savings account, money in a money market account is insured by the FDIC or the National Credit Union Administration. The catch, though, is that money market accounts often come with fees to offset their greater rate of return. If you maintain a high balance you can avoid these fees, but if you don’t you will probably pay higher fees with a money market account than you would with a savings account.
When Money Market Accounts Make Sense
Because they’re a safe place to stash your money, money market accounts can work well as a home for some emergency savings. Money market accounts pay fairly low interest rates these days, but they still may be higher than the interest rate you would get on a savings account at a bank. And in many cases, the larger the balance you are willing to keep in a money market account, the higher the interest rate you’ll receive.
Compared to a savings account, a money market account can offer a higher rate of growth – though obviously not as high as what you could get from investing in stocks. Money market accounts generally have the same advantages and disadvantages as savings accounts. The advantage is the safety of the investment. The disadvantage is the lower rate of return.
A low rate of return is significant not just because it means less growth, but because it means more vulnerability to inflation. If the rate of return on your money is lower than the inflation rate you’re actually losing money. You may be willing to pay that price for the money you keep in your emergency fund, but you probably shouldn’t put all your money in such a low-growth account unless you’re very close to needing that money for retirement.
Related Article: 6 Best Places to Park Your Emergency Fund
What About a Money Market Mutual Fund?
A money market fund is a mutual fund that holds low-risk money market securities as the account asset. They’re required by law to hold low-risk securities, but they can still lose money. Money market funds are often the default destination for investment accounts.
Say you write a check to your 401(k) provider or the brokerage that houses your tax investments. That money will often be parked in a money market fund until you make the time to sit down and put it into, say, a mix of stocks and bonds.
Putting all your savings in a money market fund and leaving them there typically isn’t a good asset allocation strategy if you want that money to grow over time and fund your retirement. Some unlucky savers have made 401(k) contributions for 20+ years, only to discover that, because their contributions all went to a money market fund, their savings have hardly grown. Plus, money market funds (unlike money market accounts) can actually lose money in a market downturn.
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You can open a money market account quickly and easily online through a bank, and/or open a money market fund through a brokerage. You can write checks from a money market account (another advantage they have over savings accounts) and in some cases you can get a debit card tied to your money market account. Happy saving!
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