Money Market Deposit Accounts and Money Market Mutual Funds
You may weigh the benefits of a money market deposit account against those of a money market fund – when it comes to cash management strategy. Both savings vehicles are ideal to help you prepare financially for intermediate-term goals, such as a home down payment and vacation package. Comparisons between the two relate to Federal Deposit Insurance Corporation (FDIC) coverage and potential returns.
Money market assets describe credit securities that mature in less than one year. Investors that buy money market assets are therefore loaning out principal to corporations and government entities. These loans earn interest until the principal is repaid at maturity. Money market fund shares carry claims over a larger asset pool that invests within money market assets.
Banks do offer money market deposit accounts to secure financing. You will earn interest on your deposit. The bank, however, may not necessarily invest these deposits into the actual money market.
As deposits, FDIC insurance does extend over money market deposit accounts. In 2010, the FDIC guarantees $250,000 worth of deposits per customer, per bank. As a larger saver, you would then divide $300,000 into three separate $100,000 deposits at three different banks – to insure the whole amount.
The FDIC, however, does not guarantee money market funds. Although money market funds lack this protection, losses on these investments are still extremely rare.
Money market mutual funds and money market deposit accounts do make similar interest payments. Total returns between these two accounts are more so a matter of expenses and restrictions. Money market mutual funds usually charge annual expenses of less than five-tenths of a percent on your account balance. In comparison, money market deposit accounts are typically free. Some banks, however, will penalize you with expensive fees, if you make several monthly withdrawals out of your money market deposit account.
Interest rates on money market funds and deposit accounts will track the federal funds rate. Banks make overnight loans to each other at the federal funds rate to meet their Federal Reserve requirements. As such, it is an important benchmark, or comparison standard for all short-term interest rates. A financial institution is more likely to invest money in situations where the possibility exists to earn a higher rate of return than is available on overnight loans made to other banks.
Money market deposit accounts and funds are both subject to inflation risks. Inflation relates to increasing prices for goods and lost purchasing power for cash. The U.S. Bureau of Labor Statistics pegs average annual domestic inflation rates at 3 percent – through its Consumer Price Index (CPI). In terms of real returns, you may therefore be losing money on savings that earn 1 percent interest rates.
The Securities and Exchange Commission (SEC) recommends diversification to allow for financial growth, while also managing risks. To build for the long-term, it is important that you also purchase stocks alongside your money market deposit accounts and funds. As a benchmark for U.S. stocks, the S&P 500 has averaged 11 percent returns since its 1957 inception.