How Do Money Market Accounts Work?

Consumers have a variety of low-risk financial instruments available to preserve their capital. With interest rates still on the rise, many options are now paying more competitive yields. From regular savings accounts to certificates of deposit (CDs), there's no shortage of ways to grow your money safely. 

A great alternative here is the money market account, which can offer competitive interest rates, safety of principal and flexibility when it comes to transactions. Here's all you need to know about what money market accounts are and how they work. 

How Money Market Accounts Work

A money market account is an interest-bearing account offered by banks and credit unions as an alternative to traditional savings accounts, checking accounts or CDs. They offer safety of principal and some income potential. 

The main feature of money market accounts is their higher interest rate compared to regular savings accounts. When it comes to interest income, money market accounts tend to pay a higher interest rate than savings accounts.

When you make deposits to a money market account, the bank or credit union offering the account will take your money and invest it in low-risk instruments like CDs, federal government Treasury bonds, municipal bonds and high-credit-quality corporate bonds and commercial paper. A portion of interest income from these instruments is then passed along to you. 

While the interest rates offered by money market accounts are generally still lower than rates on CDs, they offer greater liquidity. Unlike CDs, investors can generally withdraw their money at any time from money market accounts, whereas CDs cannot be cashed out until they mature. 

Like checking accounts, most money market accounts also offer the ability to use a linked debit card for transactions or even write checks. This may come with some restrictions or additional fees, so it's important to check the terms and conditions closely. 

In summary, money market accounts can be thought of as a hybrid between savings and checking accounts that offer high-interest rates combined with flexibility and liquidity. They can be a great tool for savers looking for competitive yields without the lockup period of a CD. 

What Can You Do with a Money Market Account?

Money market accounts are popular alternatives to savings accounts because of their flexibility and higher interest rates. Most money market accounts allow you to perform a variety of actions, including:

1. Earn interest: Money market accounts pay compound interest (interest on interest), usually monthly. The total interest a money market account pays over a year is expressed as the annual percentage yield (APY). 
2. Make transactions: Investors can withdraw from and contribute to money market accounts at their discretion, subject to possible minimum account balance requirements and limits depending on the provider. 
3. Use a debit card: Some money market accounts offer a linked debit card that consumers can use to make purchases with or withdraw cash from an ATM with. 
4. Write cheques: Some money market accounts offer check-writing abilities like regular checking accounts do, subject to possible limits and fees depending on the provider.

Who Should Use a Money Market Account?

Money market accounts can be an excellent tool for certain types of investors. Generally, individuals with short- to medium-term savings goals who require liquidity and safety of principal might find money market accounts ideal. Examples include:

1. First-time homebuyer: Someone saving for a down payment for their first home purchase can use a money market account to keep their down payment safe while earning some interest on it until they're ready to purchase. 
2. Retirees: Retired investors may keep up a year or two of cash in money market accounts to fund living expenses in case their main portfolio takes a downturn from a bear market. 
3. Savers: Keeping an emergency fund of six months to a year of living expenses in a money market account is a good idea for all savers. Unlike a CD, savings in a money market account can be withdrawn at any time you need it. 

Benefits of a Money Market Account

Money market accounts are a unique type of bank product with many advantages compared to CDs and regular savings accounts. Some examples of their benefits include:

1. Liquidity: Unlike CDs that lock up your investment until they mature, withdrawals can be made at any time from a money market account, which gives it greater flexibility. 
2. Safety: Savings held in a money market account are insured by the Federal Deposit Insurance Corp. (FDIC) or the National Credit Union Administration (NCUA) for up to $250,000 per account holder per bank.
3. Risk-free: Unlike stocks or bonds, your principal in a money market account will not lose value if the market crashes. This makes money market accounts great for investors with a low risk tolerance. 

Considerations With Money Market Accounts

While money market accounts have numerous advantages, there are also some considerations to be aware of before you open one. Common considerations include:

1. Fine print: Some money market accounts may impose restrictions on services like frequent withdrawals, debit card transactions or check writing, so make sure you read the terms and conditions carefully to see what's included and what's not. 
2. Interest rate sensitivity: The APY offered by money market accounts will vary according to the current interest rate. This can go up or down, so keep an eye on this to get the best deals possible. 
3. Inflation: Money market accounts might offer a risk-free yield, but the downside is that the rates offered tend to be lower than returns on stocks and bonds and might not outpace inflation. If your objective is growth and you can handle volatility, money market accounts might be too conservative. 
4. Fees: Because their yield isn't too high, savers should carefully examine the fees charged by money market accounts. Some common fees charged by money market accounts can include those for online banking, check writing, check cashing, monthly service fees, ATM withdrawals or excessive transactions. 

Comparing Money Market Accounts

Money market accounts can be researched and compared via various platforms. Investors looking for further insights and reviews of money market accounts can use Benzinga to compare the best money market rates here. 

Frequently Asked Questions