An overview of what a money market account is and how it works.
Are you considering opening an account that provides you with the ability to keep high balances and make a few debits each month? Or looking for a hassle-free commitment in the form of a savings account that doesn’t look up your money for a long period of time?
Look no further, we got you covered!
This article aims to offer an overview of the pros and cons of a money market account, how it works and what sets it apart from other deposit accounts.
What Is a Money Market Account and How It Works?
A money market account often referred to as money market deposit accounts (MMDA), stands as a hybrid between a savings account and a checking account. It entails many features which are not found in other types of accounts.
Banks and credit unions offer money market accounts and pay higher interest than regular passbook savings accounts. They often come with debit and check-writing privileges but, due to certain restrictions, are less flexible than standard checking accounts.
Money market accounts have monthly minimum balance requirements and maintenance fees that a customer is required to pay. Moreover, a federal law called Regulation D limits transfers and withdrawal from money market accounts, meaning that you can only get six transactions per month.
Due to the higher interest rates, one might be able to yield, depositing your money in a money market account may prove to be beneficial for savings such as emergency funds, holidays, and tax payments. In addition, they also provide federal insurance protection and are FDIC insured up to $250,000 per depositor.
Money market accounts are also available at online banks that tend to offer higher rates due to their lower overhead costs than traditional banks.
A Short History of Money Market Accounts
The federal government, well until the early 1980s, had placed a cap on the amount of interest that banks and credit unions could offer to customers who held savings accounts. To attract deposits, many banking institutions offered small appliances such as toasters and waffle irons- as incentives as they couldn’t compete with money market mutual funds when it came to interest rates.
Money market mutual fund, a type of mutual fund, invests in a selection of high quality, short term debt instruments, cash, and cash equivalents and are sold by brokerages and mutual fund companies. Introduced in 1971, people began putting their savings in higher-interest paying money market mutual funds.
Thus, facing immense pressure from the banking industry, Congress passed the Garn-St Germain Depository Institutions Act on December 14th, 1982, allowing banks to offer money market accounts that paid a money market rate higher than the previous limit imposed.
With a minimum balance of nothing less than $2500 bearing no interest ceiling and minimum maturity, money market accounts were authorized to allow up to six transfers per month and unlimited withdrawals by mail, messenger, or in person.
Advantages of a Money Market Account
Although the amount required to open up a money market account is typically higher than a traditional savings account, there are numerous benefits you can avail yourself from doing so if you’re looking for a safe space to store your funds.
1. It’s easy to access
Money market accounts come with the advantage of allowing you immediate access to your money. They act as a great option to store emergency funds that you can draw anytime you want from your account.
Hence, if you’re rushing to make an important payment, you can easily withdraw the amount you like without accruing a fee on the transaction as you might with other accounts.
Thereby, money market accounts can make a huge difference whenever you need to tap into funds required for unexpected circumstances. However, remember that money market accounts are subject to certain transaction limits; hence it’s important to check in with your respective financial institution to learn more about the rules and regulations.
2. You Can Earn Higher Interest on Your Money
One of the main advantages of depositing your savings in a money market account is that it enhances your ability to earn more interest than you usually would in a traditional checking account.
Money market accounts may have higher interest rates helping you earn more. According to the federal reserve, the national average rate for savings accounts was 0.06% and 0.09% for money market accounts in Mid-March 2021, with deposits smaller than $100,000. You can accrue even higher rates if you choose to open an account in an online bank. In addition, MMDA’s can offer higher interest rates because they are permitted to invest in government securities, certificates of deposits, and commercial papers, which traditional savings accounts aren’t.
Although money market accounts do not return substantial yields, they might grow since the Federal Reserve is expected to raise interest rates.
Hence, money market accounts can offer competitive rates compared to other types of accounts. So the better your API (Annual Percentage Yield), the more chance your money can grow significantly over time.
3. Money Market Accounts are Insured
Rest your worries aside. The funds stored in your money market account are protected by the Federal Deposit Insurance Corporation (FDIC), an independent federal government agency. The FDIC insures up to $250,000 per depositor. If you have other insurable accounts at the same bank, they will also account for the $250,000 insurance limit.
So if the institution fails, you will still be in safe hands and protected to the maximum by the FDIC agency.
4. It Offers A Range of Account Benefits
Money market accounts come with the added account benefits you receive on traditional checking and savings accounts. These include features that allow access to your funds via checks, ATM, Debit cards, and online banking.
Due to the global coronavirus pandemic, the restriction that allows one to make only six transfers out of the account per month has been suspended. However, it is most likely to return in a post-pandemic environment.
Becker, the owner of Becker Retirement Group, gives a real-life example of how the benefits of a money market account can prove to be helpful. He believes that they can come especially handy with the sale of a family house. When individuals sell a property, they are required to pay taxes on profits from the sale. Becker claims that sellers can easily park the estimated capital gains taxes amount from the sale in a money market account where it’ll earn interest. This, he points out, is a key benefit of a money market account when taxes come into play.
Disadvantages of a Money Market Account
While money market accounts offer a range of benefits in providing an outlet for storing and withdrawing money, it doesn’t come without its disadvantages.
Here’s a closer look at them:
1. Allows Limited Transactions
Due to the banking regulations laid out by the federal government, you can only make a total of six transactions per month since money market accounts are designed to maximize your savings. If you go beyond the stipulated transaction limit, you might be charged a fee. Many traditional saving accounts have similar transaction limits, whereas checking accounts don’t usually have a limit.
Due to the onset of the coronavirus pandemic, this limit has been suspended. Yet, individual banks still have the authority to impose their limitations on transactions made in money market accounts. Additionally, they can also charge a fee on withdrawals or transfers that cross those limits.
2. You Have To Maintain a Minimum Balance in Your Money Market Account
You need to have enough cash to open a money market account in the first place. While many banks may hold different rules for the minimum amount required to open an account, it is always important to check with your bank beforehand if you meet their minimum deposit requirements.
Some banks may set a threshold to as low as $1, whereas others may require a large initial deposit to open a money market account. You may also be charged a maintenance fee for dipping below the minimum balance requirement that could potentially cancel out the higher interest you earned.
Thus, your options may be limited if you have a small amount of savings or are working on achieving other financial targets, making it hard for you to gather the required amount.
3. Interest Rates May Vary
Many money market deposit accounts may offer a rate similar to the APY(annual percentage yield) you could earn with a traditional savings account. You may also have to meet a specific minimum balance requirement to qualify for a higher rate.
Money market accounts tend to have interest rates that fluctuate daily and thereby reduce certainty. Suppose you want your money to accrue a higher interest consistently. In that case, you might have to switch to other options such as CD’s (certificate of deposit) that promise better interest only if you can afford to leave your money untouched for a fixed amount of time.
The average annual return for money markets and cash equivalents is 6% per year in contrast to average returns for the stock market, which accounts for almost 10% per year. The vast disparity in the earning potential of saving vehicles will get you far less return than what you can potentially earn through stocks and bonds.
Thus, MMDA interest rates, typically higher than those found in checking and saving accounts, are much lower than the average annual return you are able to earn with long-term investment instruments.
4. Taxes and Inflation reduces the earning potential of Money Market Accounts
An increase in taxes by the federal government can reduce the amount of interest you earn in a money market account. Interest earned on money market deposit accounts is subject to taxes regardless of whether your bank calls the interest “dividends.” If you earn more than $10 worth of interest in one year, you will be receiving a 1099-INT for filing your income taxes.
On the other hand, rising inflation makes money less valuable than money today- further reducing the buying power of your money if the interest rate is less than inflation.
What Are the Alternatives to Money Market Accounts?
There are many other deposit accounts that provide similar or more superior features to money market accounts. Here’s a look at several saving vehicles offered by banks and credit unions:
1. Certificates of Deposit (CD)
Both CD’s and money market accounts offer high-interest rates on savings. However, CD’s require you to leave your savings untouched for a fixed period to as long as five or ten years. Depositors can attain a higher interest on their money than they are able to in a standard savings account. However, if you withdraw your money early on, you will be charged a penalty that takes the form of lost interest. Some CD’s may not penalize you for the early withdrawal but instead pay a lower interest rate.
While money market accounts are subject to variable APY’s, CD’s allow you to lock in a fixed interest rate throughout its entire term. That way, you don’t have to face uncertainty due to fluctuating rates that can fall or rise at any time of the day in the case of money market accounts.
Another distinguishing feature between money market accounts and CD’s is the interest rates they offer. Money market accounts are known to award higher interest rates for higher balances, while higher CD rates tend to be applicable for longer CD terms.
2. Passbook Savings Accounts
Regular savings accounts, unlike money market accounts, are not subject to minimum balance requirements. In addition, they also pay interest on savings but not more than what money market accounts have to offer. Just like money market accounts, they are FDIC insured and also place limits on the number of transactions you’re allowed to make per month.
3. Checking Accounts
Checking accounts allow unlimited transactions and thus have a significant advantage over their money market counterparts. They are specially designed for everyday transactions and are not bound by money market accounts’ transaction limits.
If you want to have immediate access to your funds without any restrictions, a checking account may be the best option. It includes various perks such as check-writing privileges and debit cards for ATM access.
However, checking accounts offer little to no interest rate on your savings.
4. High Yielding Savings Account
Depending on the institution, the interest rates offered by high-yielding savings accounts may be better than those offered by money market accounts. Unlike money market accounts, they are bound by certain requirements that include direct deposits.
What Are Money Market Accounts Good For?
The safety and accessibility of money market accounts make them excellent options for saving up for short-term and long-term needs.
You might want to consider opening a money market account if you’re looking to store money for emergency purposes. Setting aside some amount for unwanted expenses, such as medical emergencies and repairs, can help you save more and separate them from your checking account. This reduces your likelihood of caving in to temptation and withdrawing amounts for unnecessary use.
In addition, if you’re planning to save up for your upcoming vacation or new home, money market accounts offer you a secure space to park those funds while also earning interest on them. It’s also a great way of ensuring that you’re saving an appropriate amount in taxes.
How to Open A Money Market Account
After you’re done comparing the different deposit accounts banks near you are offering, opening a money market account is a fairly simple task.
You can easily set up an account online if your respective bank allows you to. You will need to follow a few procedures, which include entering your basic information such as name, address, date of birth, phone number, social security number, and so forth. In addition, you will also be asked to provide the account and routing number for the bank where you’ll be making your initial deposit. Once you’ve completed the verification requirements, you will be allowed to manage it and carry out activities that would enable you to check your statements, set up alerts, and transfer from one bank to another. You can also add money to your account through mobile check deposits or download an app that facilitates you to arrange automatic transfers. Initially, you may have to deposit an initial amount to meet the minimum balance requirements. Additionally, you may also ask your employer to deposit your salary into the account directly.
As with other types of deposit accounts, you will have to ensure that your information remains secure every step of the way. There are different ways through which you can protect your money market accounts by setting secure passwords, multi-factor authentication, and avoiding using unsecured wifi networks to access your account.
Suppose you’re looking to save up for a large expenditure in the future or perhaps want to have the flexibility of accessing your funds and earning interest on them. In that case, money market accounts might be the best option for you.
Yet, you might be limited in your capacity to withdraw funds regularly. Thus, it’s essential to map out your personal and financial goals to identify whether they align with the features that money market accounts offer. Accounting for unexpected circumstances that may arise, it’s on you to decide how to allocate your funds or apportion them across different accounts.
It would be in your best interest to have a deeper look at your finances and draw out the various options that’ll allow you to maximize your savings. For many people, money market accounts serve as a great alternative to save up for long-term needs and earn small interest boosts on their savings over time.