What You Need to Know About Money Market Accounts

Cash accounts are having a moment, thanks to the decent interest rates they now pay, at long last. But selecting one can be a daunting task given the profusion of choices —from money market accounts to money market mutual funds to a small clutch of newly hatched money market exchange-traded funds.

The term money market has become a catch-all description for a variety of interest-bearing products that follow different rules. The offerings also vary in yield, ease of accessibility and, to a small degree, levels of safety. “In some respects, money market has become more of a marketing term than a technical term,” says Ted Rossman of Bankrate, a website that evaluates bank products. “There's a lot of confusion about this.”

What's an investor to do? We'll lay out the various types of money market investments, all of which invest in high-quality, short-term debt and are appropriate places to stash cash for short- to medium-term goals, as well as what factors to consider before you choose one. We're holding off on including money market ETFs in this discussion, however, because most are less than a year old.

First, an explanation about money market interest rates. They fluctuate, for starters, depending on market conditions and how their holdings perform. And you will see a variety of interest rates quoted. Each one offers an idea of how much your cash can earn over a 12-month period, but they're not exactly the same.

Mutual fund money markets are required to report a seven-day SEC yield, which shows what the fund would pay in interest over a one-year period if rates of the past week stayed the same. It's net of fees, so investors can compare one money market mutual fund to another.

Money market accounts quote an annual percentage yield (APY), and that reflects compound interest — the return you earn on principal plus accumulated interest. That's different from a straight-up interest rate, which you also may see quoted.

They're FDIC insured up to $250,000 if the bank fails. Monthly fees may apply, too, unless you maintain a certain balance.

Quontic Bank's money market account, for example, requires $100 to open. There's no maintenance fee. And the bank pays the same interest — 3.8% currently — whether you have $1 or $150,000 in the account. It comes with check-writing abilities and a free debit card, too. “This is really a pretty standard bank account that's being marketed as a money market,” Bankrate's Rossman says.

You open these accounts at a bank or credit union. They offer easy access and may yield more than an ordinary savings account. You may have to fork over a certain amount, $100 or even $5,000, to open one. But most allow you to pull some or all of your money at any time. Some accounts even offer check-writing abilities.

You buy these funds through your broker. There are three types, distinguished largely by what kind of debt they hold.

Government money market funds invest in short-term Treasuries and other government securities. The biggest such fund, Fidelity Government Money Market Fund (SPAXX), yields 3.3%.

By contrast, municipal money market funds invest in state and local government debt, which pay interest that is exempt from federal taxes. American Century Tax-Free Money Market Fund (BNTXX) boasts a 3.1% yield, or a taxable-equivalent yield of 4.1% for investors in the 24% federal income tax bracket.

Some muni money funds focus on debt in a single state, giving residents of those states additional tax benefits. Schwab California Municipal Money Fund (SWKXX) yields 2.4%. For California residents in the 24% federal income-tax bracket, the taxable equivalent yield is 3.7%.

Prime money market funds can hold a mix of government bonds and commercial paper — high-quality, ultra-short-term corporate debt. The largest prime fund by assets, Schwab Prime Advantage Money Investor (SWVXX), holds 20% of its assets in commercial paper. It yields 3.5%.

Generally speaking, all money market mutual funds are safe investment products, but they have some risk. These funds are designed to maintain a stable net asset value of $1 per share, for instance, but during the Global Financial Crisis, a money fund fell below that — it “broke the buck.” Regulators now require that money funds hold a chunk of their portfolio in cash reserves.

Underlying holdings in the money fund can inject some risk, too. Prime funds that hold commercial paper stakes, for instance, are a bit riskier than funds that hold only government securities. That's partly why prime funds offer a tad more yield than government money market funds.

But since the post-GFC cash-reserve rules went into effect, much of the yield advantage in prime funds has been diluted. That's why some advisers, including Brian Schaefer at Johnson Financial Group, have decided prime funds don't offer enough yield these days to justify the risk.

SIPC insurance covers money mutual funds up to $250,000 in cash if a brokerage firm fails; the insurance does not cover investment losses.

Factors to consider

Yield matters, but you may want to consider additional features before choosing a money market product.

Accessibility. Whether you choose a money account or a money mutual fund may boil down to where you plan to hold your cash, whether in a bank — which provides arguably easier accessibility, if you're moving money between household accounts—or at your brokerage firm. Either way, make sure you can withdraw any amount of money, anytime you want. Some may cap monthly withdrawals.

And if you opt to keep your cash at your brokerage firm, don't assume the default cash account earns a decent yield. At Schwab, the default fund for idle cash in brokerage accounts earns just 0.01%. That's fine for money you plan to spend or invest in the next few days or weeks. Otherwise, consider moving it to a money market mutual fund or account to boost your yield.

Tax consequences

The tax treatment on interest earned in money markets can help you narrow your choices. Muni money market funds, for instance, are a good choice for high-income earners holding cash in taxable accounts.

Interest income in other types of money accounts and funds is subject to ordinary federal income tax, though most government fund payouts are exempt from state and local income taxes. The exception is government repurchase agreements, or repos, which generate income that's subject to federal, state and local taxes, says Noreen Brown, an adviser at Summit Financial in New Jersey.

Fees

Whether it's a monthly maintenance fee in a money market account or an annual expense ratio in a money market fund, investors should look at expenses when picking money market products, says Brown. Monthly maintenance fees for money accounts range between $0 and $25. Expense ratios of the 10 biggest money market mutual funds range from 0.11% to just under 1%.

Truth be told, however, depending on how much you're stashing away, expenses may not matter that much. “If you're investing $10,000, who cares?” says Pete Crane, who runs a data firm that tracks money market products. “A million dollars? Yeah, you should care.”

As seen in Kiplinger.com