What Is a Money Market Account and How Do They Work?

By Phil West, WCI Contributor

During eras of historically low interest rates, people who would generally be content with savings accounts look for other options. The money market account is one of those options, offering higher yields on average than traditional savings accounts while still being relatively liquid for those who want the money close at hand.

 

What Is a Money Market Account?

A money market account is maintained by a bank or a credit union and is essentially a hybrid between a savings and a checking account. It typically has a higher yield than a bank or credit union’s savings account option. That's its appeal. But it also usually has some limitations to how often you can withdraw money. It also typically requires a greater initial deposit than a bank or credit union’s savings and checking account packages.

Money market accounts were made possible through legislation passed by the US Congress in the early 1980s. Congress passed the Garn-St. Germain Depository Institutions Act of 1982 to allow banks and credit unions to offer money market accounts to customers. Previously, those bank and credit union customers either had to settle for the capped rate of a savings account or to step up to a money market fund, which offered higher yields but less flexibility.

 

Are Money Market Accounts Covered by FDIC Insurance?

Like a savings account, a money market account opened via a bank is insured by the Federal Deposit Insurance Corporation (FDIC). The FDIC, which started during the Great Depression, is a federal government entity protecting consumers. According to its website, it was established to “maintain stability and public confidence in the nation’s financial system.” FDIC protection covers you for $250,000 per bank across all your investments, and that goes up to $500,000 if it’s a joint investment with your spouse.

If you’re going the credit union route, the National Credit Union Administration provides the same level of protection.

 

How Does a Money Market Account Work?

If you know how savings accounts and checking accounts work, you understand the basics of a money market account. Depending on the bank or credit union, you’ll need to start with a certain level of investment to open the account and then maintain a certain amount in the account each month to get the highest yield possible and to avoid possible bank fees.

For example, a bank might require you to invest $1,000 to open a money market account and then charge you $10 a month if you let the balance go below that $1,000 level. A bank might also offer different annual percentage yield (APY) rates depending on how much money’s in the account, so you’d have a higher yield with $5,000 in the account than you would with $1,000.

The money market account will likely also come with hallmarks of a checking account, including a debit card—though you’ll likely be limited on the number of transactions you can make. (A number of institutions cap money market account withdrawals at six per month.)

More information here:

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What Are the Benefits of Money Market Accounts?

The most obvious benefit of a money market account is an interest rate that will usually outperform a traditional savings account. As Investopedia notes, “MMDAs can offer higher interest rates because they are permitted to invest in certificates of deposit (CDs), government securities, and commercial paper, which savings accounts cannot do.” Some tax-free money market funds also use municipal bonds.

And yet a money market account has the functionality and flexibility of a savings account, making funds invested there more liquid than they would be in bonds, Treasury bills, or stocks. A money market account is a good option if access to the money you’re investing is important to you.

 

What Are the Disadvantages of Money Market Accounts?

While a money market account does have a higher yield than a savings account, it’s only marginally higher compared to all the other investment options available to you. If you’re looking to grow an investment over time, a money market account isn’t the best place to do it.

While a money market does allow access and flexibility, it’s not absolute—you have to be mindful of the rules the bank or credit union set up and what level of investment you need to maintain to make it worthwhile.

Also, keep in mind that while money market accounts tend to have a higher interest rate than savings accounts, this is NOT always the case. Sometimes, they do. Sometimes, they don't. You need to continue to check interest rates and potentially move money back and forth between a savings account and a money market account. If you feel the need to pay close attention, that constant churn could be a hassle.

 

Can You Lose Money in a Money Market Account?

As long as you’re maintaining your money market account, you should be able to grow your investment over time. However, between fees and penalties that might be assessed by your bank or credit union, it is theoretically possible to lose money with an MMA. That’s especially true if you make withdrawals that then, due to a lower account balance, trigger penalties and lower APY rates.

 

How to Open a Money Market Account

First of all, make sure the bank or credit union you want to open an account with has a money market account option available. You can likely do this online anytime, or you can simply call or visit during regular business hours.

Then, it’s a matter of either investing money anew or transferring it from an existing account. Make sure, however, that you understand the rates and rules as you start. If you’re working with a bank or credit union for the first time, you’ll need to provide what you would when opening any type of account, including proof of identity and your Social Security number.

 

Money Market Accounts vs. Savings Accounts

Choosing between a money market account and a savings account boils down to how much money you plan to put and keep in your account. If you feel you can meet and maintain the right minimum amount, you’ll make more money over time with a money market account since you'll have a higher interest rate.

 

Money Market vs. Checking Accounts

A money market account allows you withdrawals as a checking account does, either through a debit card transaction or an actual check you’d write and sign. However, you’ll only be allowed a set number of checking-style transactions each month. If you go beyond that, you’ll be assessed charges that could offset the interest gains you make. If you need to access the money in a money market account more frequently than the rules allow, a money market account might not be right for you.

 

Money Market Accounts vs. Mutual Funds

If you’re looking to invest money and get a higher yield than a bank or credit union might offer, you may want to delve into mutual funds. A mutual fund pools money from a number of investors; buying into one allows a fund manager to invest on your behalf aiming to make all the investors money. It could be commodities like oil or gold, it could be stocks, or it could be more conservative investment vehicles. There’s a great variety available to suit your investment budget and risk tolerance.

While mutual funds can make you more money over time than a money market account, they’re not guaranteed like a money market account. If you lock into a specific, FDIC-protected money market account rate, you know what money you’ll make (provided you play by the bank’s rules). With a mutual fund, there’s absolutely no guarantee of how much money you’ll make; you could even lose money depending on the market and where the money’s being invested.

More information here:

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Alternatives to Money Market Accounts

Money market accounts are sometimes confused with money market funds, and the latter can actually be a good alternative to the former. Investor.gov, the SEC’s website, defines money market funds as “a type of mutual fund developed in the 1970s as an option for investors to purchase a pool of securities that generally provided higher returns than interest-bearing bank accounts.”

They’re not FDIC-insured, but they’re considered lower risk than many other investment vehicles, and they can provide higher yields than money market accounts. Some are attached to federal or municipal debt securities, and some financial companies offer these types of money market fund investment options.

You can also directly access U.S. Department of Treasury yields through T-bills, Treasury bonds, and Treasury notes. Of the three, T-bills mature most quickly. Those are typically available in $100 increments and mature in a year or less, depending on what you specifically pick. You can go through a bank or broker to purchase these, and for some types, you can even purchase directly through the TreasuryDirect site maintained by the Treasury Department.

 

Should You Put Money in a Money Market?

Certainly, there are better places to put your money than a money market—if you’re looking to make gains beyond the modest interest rates that a money market will bring you. However, if you’re looking to stash some money in a savings account, a money market, for its combination of safety and liquidity, might actually be what you’re looking for. A money market account has all the advantages of a savings account—provided you can keep the right amount of money in it—and you’ll make a little more in interest along the way.

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