Money Market Accounts and FDIC Insurance
For many, a money market deposit account is an integral component of an effective cash management strategy because it combines safety of principal alongside the ability to collect interest payments. As with any banking deposit, FDIC insurance guarantees your money market deposit account balances. It is important that you understand how FDIC insurance works, before putting together a complete financial plan. Maintaining total cash reserves worth three months of living expenses would be ideal.
The Money Market
Money market deposit accounts are distinct from money market securities and mutual funds. Money market securities and funds are investments into credit instruments that mature in less than one year. As investments, money market securities and funds are not guaranteed by FDIC insurance. Again, the FDIC does back bank-offered money market deposit accounts. Banks do not necessarily invest your money market deposits into money market securities.
FDIC coverage extends over $250,000 worth of deposits per customer, per bank. The FDIC defines bank deposits as certificates of deposit, alongside checking, saving, and money market deposit accounts. If you are a larger saver, you will divide a lump sum of cash between several different banks to insure the entire amount. For example, you may divide $400,000 into four separate $100,000 money market deposits at four different banks – to maximize your FDIC coverage.
Money Market Returns
In exchange for safety of principal, you must be willing to accept relatively minimal returns for money market deposit accounts. Over the long term, money market deposit account returns will be significantly less than both stocks and bonds. Money market interest rates closely parallel the federal funds rate. Banks make overnight loans to each other to help themselves meet their Federal Reserve requirements. Banks charge interest on these loans at the federal funds rate, which serves as a benchmark for all other interest rates. The Wall Street Journal publishes federal funds and money market deposit account rates daily.
Money market deposit accounts are especially susceptible to inflation risks. Inflation relates to a higher price level for goods and services, which translates into lost cash purchasing power. The Bureau of Labor Statistics calculates an average annual domestic inflation rate of 3 percent–through its Consumer Price Index (CPI). Over time, money market deposit account purchasing power will erode significantly.
Money market deposit accounts are ideal to help you build toward intermediate-term savings goals, such as a mortgage down payment or start-up business costs. You may also put money into a money market deposit account to provide financial relief amid emergency situations, which may include job loss or hospitalization. Beyond your money market account, it is important that you diversify into stocks and bonds to allow for long-term financial growth. Stocks perform well during times when the economy is strong, while bonds generate interest payments in most economic conditions.