Thursday, August 14, 2008

Learn the lingo: Money Market Accounts

When people get together to chat about CDs (all right, maybe they aren't the ultimate topic of conversation, but we'll pretend they are), what usually peppers the same discussion is the ever-elusive "money market account." From there, people tend to take opposite sides of which investment vehicle is the best, pointing out the pros and cons of each, which is more affordable to start with, etc.

If you're new to the game and don't like asking what you perceive as "stupid" questions, it's at this point in the what-seems-like riveting discussion that you retreat, appletini in hand, and quietly listen like a ladybug on the wall. Perhaps you don't know what a CD is (if not, check out my earlier post on the gem). Perhaps you also don't know what the money market is (for many, visions of a market made of money come to mind). To get more engaged in your friends' financial tete-a-tete, though, and further your own investment knowledge on the matter -- after all, that's probably why you're reading this -- it's time to get back to the basics!

First off, the money market and money market accounts are two separate things. The money market is a unified name for the myriad of ways that banks, companies, governments, etc. borrow and lend money. Those different ways include taking the shape of: 
  • Treasury bills 
  • short-term certificates of deposit 
  • short-term municipal bonds 
  • government securities (such as those issued by Freddie Mac and Fannie Mae) 
  • money market accounts 
Still fuzzy on the whole phenomenon? Think of it as the stock market (where stocks are bought and sold), but instead it's money that's bought and sold, and for shorter periods of time (never over a year). 

Of course, the whole point in investing in the money market with your cash versus leaving it in a savings account is that by loaning the bank or government your money, they are paying you back high interest for doing them a favor. In other words, you'll be earning more back on your money, which makes it a better investment because of the higher, yet lower-risk return on it (compared with the high-risk, high-yield returns you can get from investing in, say, the stock market). Interest rates can fluctuate with almost any investment, but they only tend to really hurt your money with wide rises and falls, which happen over years. One of the bonuses with a money market investment is that since it's such a short-term thing (again, about one year), in a sense it shelters your money from wide swings in interest rates. Simple, no?

Now that you're an ace in money market lingo, you'll need to know the different between a money market account and a money market fund! A money market account is very much like a CD, except it has the perks of a checking account (i.e., you can write checks with said money and withdraw it more freely without any CD-like penalty). Unlike a checking account, though, a money market account comes equipped with a higher interest rate (score!!). They are good savings vehicles for ladies on a budget who want the ease and simplicity of strutting into a bank and opening an account, and who may also need instant access to money and therefore might not want to pay the penalty to withdraw cash asap. 

One caveat to remember is that even though you can access your money more freely through a money market account, there are still restrictions in terms of how many times you withdraw per month, or how many checks you write, but typically it's about 3 to 6 times monthly, which I don't think is at all that bad. Anything more and it might be time to reevaluate if you should be saving in a money market account at all! 

Also, many banks require you keep a minimum balance in your money market account (usually $1,000 to $2,500), so make sure you understand your individual bank's requirements about minimums, frequencies of withdrawal, etc. And last but not least, unlike interest rates in a CD (that directly correlate to maturity), interest rates in money market accounts are proportional to how much you have in your account, versus how long you keep it in the account. Translation: The lower the balance in your money market account, the less interest you earn from the bank, and the less it benefits you in the long run. By the that same token, the more you keep in the account, the wealthier your investment leaves you.  

A money market fund is a type of mutual fund where once your cash is invested, money managers reinvest it in the aforementioned savings vehicles of Treasury bills, municipal bonds and the like. The initial investment in a money market fund is higher than what might put into a savings account (think at least $1,000), but again, the interest you earn on your money is higher. Like money market accounts, cash can be pulled from these funds the instant you need them, but usually come with high minimums of around $500 (depending on where you invest), so constantly withdrawing money might not make it the best investment. 

When looking into investing in money market accounts or funds, be armed and ready with a checklist of questions for the bank, including: 
  • What's the minimum deposit to partake in one?
  • How much of a minimum balance do you need to sustain in the account?
  • How many times can you access your money on a monthly basis, and what are the limits like on writing checks?
  • What do the general interest rates over a 3-month, 6-month or 12-month period look like on the money you plan to deposit?
  • What kind of penalties come with the account?
Then ask yourself these questions:
  • Are the penalties something you could or would be willing to pay if you had to?
  • How much are you planning to invest in the account? How does this measure up with the minimum?
  • Do you think you'll need to incessantly draw money out to cover for bills or other payments, or do you see it as more of a "put it away and forget about it" investment? After all, the more you put in and less you withdraw, the higher interest you end up earning.
Now with all of that said, chickadees, do you feel armed and ready to discuss the merits of money markets, accounts and funds in your next financial pow-wow with friends? Even better, do you feel like a money market account is the right investment for you money? Don't forget to ask yourself and your bank the above questions when figuring out what's right for you. Happy investing!


Budget Mama said...

Great info. I was thinking about a MMA to save $ for my son's medical expenses. Still researching the matter more.

Anonymous said...

Useful stuff! I'm embarrassed to say I didn't realize that money market and money market accounts were different.

The one thing you didn't mention -- and I'm pretty sure this is true but correct me if I'm wrong -- is that the money markets aren't FDIC insured. CDs are. There is an assured rate of growth.

And, of course, you generally get the best rate around 9 or 12 months -- much longer and the bank lowers the rate, in case you lock in at a great rate, only to have the going-rate plummet. Then the bank is left obligated to overpay you (in its opinion). So in order to compensate for the risk its taking with a longer CD, the bank rarely offers spectacular long-term rates. Usually they're not much different than the under-one-year rates.

Crystal said...

Thanks guys! Abby: Money market accounts are FDIC-insured, it's the money market funds that aren't. But being FDIC-insured does not assure any rate of only get that if you sign up for a CD.

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