A Money Market Account is a good way to earn higher interest rates without locking your money up for a long period of time. In many ways a money market account is like a certificate of deposit, but with much more flexible terms.
There are many ways to save your money and earn a little interest in the balance. A money market account falls somewhere between a regular checking account, and a certificate of deposit.
Unlike a certificate of deposit, a money market account will allow you to access your funds with some regularity, but it isn’t going to be as flexible as a checking account. Depending on your financial situation, depositing your money in a money market account could make a lot of sense.
A Money Market Account is a Flexible Solution
If you have some extra money that you don’t think you will need, depositing it in a money market account could be a good idea. Instead of letting it sit in your checking account where it won’t earn you much, a money market account will boost your passive income.
A money market account has some great features that allow you to earn extra income, while still having access to your money. If you need to have access to your savings on a weekly or monthly basis, a money market account could be a good fit.
Every money market account will have different rules, which is something to consider before you decide to open one. You can deposit money that you don’t need right away, and withdraw it if you need to at any time.
Money market accounts let you have the freedom to withdraw your money, but also give you a higher interest rate than most basic savings and checking accounts!
How do Money Market Accounts Stack Up?
You might be wondering why you would consider a money market account, and not just a basic checking account or certificate of deposit.
Let’s break down each account type:
A checking account is made to be used on a regular basis and generally won’t have any fees to write checks, or use a debit card that is linked to the account. While you will have easy access to your funds, the interest rate that is paid by the bank on your deposit is likely to be low.
- Pros Easy access to your money and no fees to use your funds.
- Cons Super-low interest rates.
Money Market Account
Money market accounts offer better interest rates for savers. In most cases, a money market account will have a higher minimum deposit than a regular checking or savings account, and most offer a debit card or electronic transfer capability.
- Pros Higher interest rate, and the ability to access funds on a limited basis without penalty.
- Cons May have a higher minimum deposit than other accounts, penalties could apply to excessive withdrawals.
Certificate of Deposit
In general, a certificate of deposit will offer savers the highest amount of interest on their deposits. On the downside, the money will be ‘locked up’ for the duration of the deposit.
- Pros Usually the highest interest rate product from a bank.
- Cons No way to access your fund without a penalty.
The Savings Ladder
It might be a good idea to think of your savings as existing in the form of a ladder.
The lowest rung of the ladder is a basic checking account because you are going to need access to cash for daily expenses. While a checking account isn’t going to give you much in terms of return on your deposit, you will be able to quickly and easily make deposits and withdrawals any time you like.
As you save more money, you can consider moving up to the next rung on the savings ladder. A money market account combines some of the flexibility of the checking account while pumping up the rate of return you will receive on your deposit.
It is probably a good idea to think about a money market account as an intermediary between your checking account, and longer-term investments that should only be accessed in case there is an emergency.
If you run short on funds you will have the ability to tap your money market account without having to worry about penalties, but the goal of saving is to move up the savings ladder.
A certificate of deposit is the last and highest rung on the savings ladder that you are probably going to find at your local bank. The money that you deposit in a certificate of deposit will be locked-up for at least a few months, and you won’t be able to touch it during that period.
Once you are able to maintain and grow your savings at a bank, it is a good idea to keep going up the savings ladder and put some of your long-term investment money into an IRA, or some other form of a tax-deferred account.
Does Investing in Interest-Bearing Accounts Make Sense?
You might have noticed that interest rates haven’t been as high as you remember them being when you were younger.
Over the last ten years, global central banks have slammed interest rates to the floor, and it looks like they are set to fall again. The result of this in the world of fixed income investment is falling rates and a much harder time for people who want to earn a risk-free return.
Keeping a lot of your money in interest-bearing accounts isn’t as compelling as it once was. In fact, the central banks are now talking about using negative interest rates as a tool to spur economic growth.
Large amounts of European government debt is currently trading with negative interest rates, which means that investors are guaranteed to lose money when they buy the bonds. If this becomes more widespread, there may be a point when your local banks force you to pay to deposit money.
Interest Rates and Inflation
Most people rarely consider the effects of inflation on their savings. Every year money that sits in a low yielding account actually loses value, because inflation erodes its buying power.
The US inflation rate itself is something of a mystery because the formulas that are used to create it have changed radically over the last 3 decades. There is a clear bias by the government statistics office to understate the rate of inflation, as high inflation is politically unpopular.
Even if we use the official inflation figures, which are clearly understating actual inflation, we see that annual inflation in the USA has varied from less than 1% to over 2% in the last decade.
If we use the same methodology that the government used to calculate the exact same statistics in 1990, we can see that inflation has been above 5% for most of the last decade.
In practical terms, this means that a money market account that pays you 2% in interest a year is actually losing 3% per year in inflation-adjusted terms.
A New Easing Cycle is Here
There is a very good chance that we have seen the highest interest rates from the current cycle, and global interest rates will head much lower over the next two years.
Central banks from smaller economies, like South Korea, India, South Africa, and New Zealand, have already started on a fresh rate cutting cycle. Major central banks are expected to do the same over the next few months, which means that fixed-income investments will probably be less attractive over the medium term.
All of this rate cutting means that anyone who is considering a money market account should be aware that their rate of return is likely to fall over the coming months and years.
Good Ways to Use a Money Market Account
Given the outlook for fixed income investments, it is good to think about a strategy for a money market account, and how you plan to use it.
A money market account will give you easy access to your cash, as well as a higher interest rate, but any returns you make will be taxed, and the interest you receive is unlikely to outpace inflation.
In an environment where rates and inflation-adjusted returns on fixed-income investments fall, it is important to maximize any possible returns by taking advantage of anything that can boost your bottom line.
From a practical perspective, it makes sense to move your money up the savings ladder as quickly as possible, so that you can take advantage of fixed interest rates, as well as tax-deferred retirement accounts.
Of course, you will need to have some cash around. Here are a few good ways to use a money market account.
- Emergency Savings Everyone should have a rainy day fund that can be accessed quickly and without penalties. A money market account is a perfect fit for this rainy day fund. How much you decide to sock away if up to you, but at least two months of expenses is a good place to start.
- Small Business Tax Account If you are responsible for saving the taxes that your small business has to pay, a money market account is a good place to do it. In addition to keeping your tax money in a segregated account, you can earn a little interest on it before you have to pay it to the government. You can also set up direct payments from a money market account, which will make paying your taxes a snap.
- Saving for Bigger Things Putting money away to buy big-ticket items is a whole lot smarter than going into debt to get them. A money market account is a good place to stash your cash while you save up for a car, major appliance or any other big purchase. You could also use a certificate of deposit, but the money market account is nice because you can access your cash whenever you want.
Your Money is Safe With a Money Market Account
As long as you deposit your money with an FDIC insured bank, or an NCUA insured credit union, any losses will be covered by up to $250,000 USD. This coverage extends to money market accounts, which make them a very safe way to hold on to your money.
Keep in mind that the $250,000 worth of insurance is generally applied to a single depositor in any given institution, so if you already have $250,000 on deposit with a bank or credit union, an additional account may not be covered.
Is a Money Market Account Right for You?
Using a money market account as an intermediary step on the savings ladder could make a lot of sense for many people.
A money market account is certainly a better choice than a normal checking account, which isn’t likely to yield much in the way of interest. As a fixed-income investment, money market accounts straddle the line between a regular bank account and a longer term savings vehicle.
If you need a way to stay flexible with your money, and still gain a little extra in interest payments from your bank, it would be a good idea to look at your options for a money market account.
Things to Keep in Mind When Opening a Money Market Account
There are numerous money market accounts out there to choose from. Most will have a minimum deposit, but some can be opened with as little as one dollar.
Two areas that are especially important to pay attention to are the fees, and interest rate.
The fees on a money market account can vary widely. The number of withdrawals that you can make without a penalty is probably limited, so find out all the details before you give the bank or credit union your money.
The interest rate that your money market account pays is also important to understand. Many banks use an introductory rate that will fall after a given time, so make sure you understand how that works upfront.
Overall, money market accounts are a worthwhile financial tool and could make sense for many retail and business banking customers.