Despite their similar names, money market accounts and money market funds are most certainly not the same thing. So let’s take a look at both to clear up whatever confusion might exist and provide insight into which will best suit your particular needs.
Money Market Accounts
A money market account, also known as a “money market deposit account,” is essentially a savings account. Money market accounts tend to pay more in interest than standard savings accounts and have higher minimum balance requirements but are interest-bearing bank accounts at their core, typically allow for limited check writing and debit card use, and most importantly, are explicitly insured by the FDIC—usually for up to $250,000.
Some money market accounts are intended specifically for young people and may have penalties for withdrawals before a certain time—the account holder’s 18th birthday, for example.
Money Market Funds
A money market fund is a type of mutual fund required by law to invest in low-risk, short-term debt securities (e.g. Treasury bills, commercial paper, asset-backed securities and other highly liquid credit instruments). Their dividends tend to mirror short-term interest rates, and since they are not federally insured, their value isn’t ultimately guaranteed.
The industry, however, does attempt to keep money market funds from losing any value, and the Investment Companies Act of 1940 restricts them from being composed of anything but high-quality debt securities. Moreover, when money market funds began registering a negative return in September 2008, the Treasury stepped in, offering a program that would temporarily insure the funds, thereby adding a measure of implicit security to this type of investment.
While the degree of stability obviously depends on what kind of fund you invest in (those supplied by government securities, or short-term Treasuries are the most stable), money market funds are known for their general consistency, regardless of their exact nature.
The general rule of thumb for choosing between a money market account and a money market fund is: Unless a you can get a significantly better return on your investment by using a money market fund as opposed to a money market account, the better-insured investment is probably the best place for your money.
With that being said, let’s take a look at current rates of return for both money market accounts and money market funds and see what disparity currently exists. The average APY for money market accounts is 0.28%, which is much higher than the latest annualized yield of 0.02% for the Vanguard Prime Money Market Fund, which has outperformed the average money market fund for the past few years. Therefore, in the current environment, why would anyone consider investing in a money market fund for any reason other than restrictions imposed by their retirement account?