What is a Money Market Account?

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After the recent events in the financial industry, many investors are looking for a more secure, less risky way to invest their money without sacrificing returns for safety. For many conservative investors, money market accounts offer the perfect solution. But what is a money market account? Unlike a certificate of deposit, a money market account is a flexible instrument with no fees for withdrawal. But there is definitely more to a money market account than just flexibility.

Money Market Basics
A money market account is very similar to a savings account. It is a deposit account, generally FDIC insured (as long as you bank with an FDIC insured institution), that earns more money than a traditional savings account generally does. And this is where money market accounts get interesting:

You see, while a savings account earns interest by being loaned out to other bank customers, a money market account earns money by having underlying investments. Basically, the money that you deposit into the money market is pooled with other investor’s money and is used to buy certificates of deposit, government bonds and other low-risk securities. This allows the bank to profit from your money market account balance while still paying you interest. And while the bank only gives you a portion of the earnings on these instruments, it generally amounts to a greater interest rate than you would earn with a savings account.

It is important to note that while money market account returns are paid much like savings accounts, your bank or brokerage firm may refer to them as dividends rather than interest. You should check with your accountant to determine how they are taxed.

Money Market Account Options
When you initially ask, what is a money market account? You will be bombarded with information. Once you sort through the information and have a good hold on the basics you need to think about some of the other options that money market accounts afford you.

For instance, many banks and brokerage firms will allow you to have a money market account that functions as a checking account or one with ATM access. While this does help to make your money more accessible, it can also make it more difficult to save money if you have such easy access to your funds. Other options include using a money market account for overdraft protection which can also hurt your ability to save steadily.

And finally, you must consider how much you want to deposit into your money market account. The more you deposit, the greater your interest rate or dividends will be, but you must consider whether or not that money would do better deposited in a higher-interest investment or a qualified account that doesn’t tax your growth until you begin taking distributions (if at all). Running the appropriate calculations for each of these scenarios is an important step in ensuring that you make the best decision with your money.

Money Market Accounts versus Funds
One of the reasons money market accounts are so confusing is that they are often taken for a similar vehicle, the money market fund. A money market fund is NOT a deposit account. Instead, it is structured like a mutual fund, although it will often have underlying investments similar to those of a money market account. Money market funds are purchased by shares, have a net asset value, and earn dividends based on the performance of the underlying investments.

Money market funds can be purchased in a brokerage account or retirement account, like an IRA, but cannot be purchased in or added to a money market deposit account. Money market funds do give investors slightly more control over what they ultimately invest in since many funds have segmented underlying investments. This means that you can restrict the types of underlying investments you are exposed to by purchasing specific funds with a single type of underlying investment. This is especially helpful to investors who want to invest in money market funds with tax-free municipal bonds as underlying investments.

An additional difference is that money market funds may impose certain loads, or charges, either at the point of purchase or sale. These may even be combined with the charges for holding a brokerage account.

Money market accounts are a valuable tool for any investor’s kit. They offer an effective and low-risk way to diversify a portfolio, while also providing some potential for slow growth. Not necessarily suited for all long-term investing needs, they also offer the perfect investment for short-term finance holding.

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