Investing money can be risky. There are several important things you need to think about before deciding to invest in something. For example, if you put your money into stocks, you have to be ready for the possibility that the value might go up and down a lot because of changes in the market and the economy. When you buy bonds, there’s a chance that their value could be affected by changes in interest rates and inflation.
However, if you’re looking for a safer option, you can consider a money market account. Money market accounts are useful because they help us keep our money safe and accessible. Despite their benefits, these accounts are sometimes not well understood and not used correctly.
So, what exactly are money market accounts, and how can you avoid making mistakes when you use them for your investments? Keep reading to learn about the five most common errors that people make when they use money market accounts.
What Are Money Market Accounts?
To begin, it’s essential to grasp the concept of these accounts and what advantages they bring. Money market accounts are types of bank account held at banks or credit unions. They are often called money market deposit accounts (MMDA) and have features that set them apart from regular savings accounts. These accounts are particularly useful when you want to keep your money safe for a short period, especially when the financial markets are unpredictable and there’s no clear safe option.
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When you have a money market account, you can be confident that the Federal Deposit Insurance Corporation (FDIC) will insure your balance up to $250,000.
Many money market accounts allow you to write checks and use a debit card. Some banks, however, put a limit on the number of transactions you can make with this account. Up until April 2020, the Federal Reserve limited this to six transactions, but this rule was changed to help people during the Coronavirus pandemic. However, banks still have the power to set their own limits.
These accounts earn interest, usually with single-digit returns, and the interest may be a bit higher than what a regular savings account offers. This is because money market accounts can invest in safe and stable funds like Treasury bonds (T-bonds), which tend to have better interest rates than savings accounts. Even though the returns might not be extremely high, money market accounts are a sensible choice when things are uncertain in the financial world.
Misconception #1: They Are Money Market Funds
Confusing a money market account with a money market fund is a common mistake, but there are important differences between these two financial tools.
A money market fund is a type of mutual fund known for its low-risk, low-return investments. These funds put money into very liquid assets, like cash and securities that can be quickly turned into cash. They also invest in short-term debt-based securities that have high credit ratings. Buying and selling shares in a money market fund is relatively easy, and there are no fees associated with these transactions.
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However, it’s often assumed that when people hear “money market,” their money is entirely safe. But this isn’t the case with money market funds. These accounts are still an investment, which means they don’t come with the guarantee from the FDIC (Federal Deposit Insurance Corporation).
The returns from a money market fund depend on the interest rates in the market. These funds can be grouped into different types, like prime money funds that invest in non-Treasury assets like commercial paper, or Treasury funds that invest in U.S. Treasury-issued debt like bonds and notes.
Misconception #2: They Are a Safeguard Against Inflation
A common misunderstanding is thinking that putting money in a money market account will protect you from inflation. However, this isn’t necessarily accurate.
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Many people suggest that it’s better to earn a small amount of interest in a bank rather than earn nothing at all. However, the main purpose of a money market account is not necessarily to beat inflation over the long term. Instead, its goal is to help your savings grow more quickly compared to regular checking or savings accounts.
Let’s consider an example where inflation is lower than its 20-year average. Even in this scenario, the interest rates that banks offer on these accounts also decrease, which affects the original purpose of the account. So, while money market accounts are safe ways to invest your money, they don’t guarantee protection from inflation.
Misconception #3: A Large Allocation Is Efficient
The way inflation rates go up and down can affect how well money market accounts work. To put it simply, having a lot of your money in these accounts isn’t the best idea.
Normally, experts suggest keeping enough money in cash in these accounts to cover about six to twelve months of your living expenses. This is a good buffer for unexpected emergencies and important life situations. But if you keep more money than that, it’s not really doing much. It’s just staying there and losing its value over time.
Misconception #4: They Are the Most Beneficial Option
In many situations, we’re taught to think that keeping a lot of money saved up is the best way to go. However, this isn’t always true, especially when it comes to putting money in money market or regular savings accounts.
It can be tough to let go of money you’ve worked hard to earn and put it into the uncertain world of investments. Unfortunately, many people end up keeping their money in cash for too long out of fear, instead of investing it.
The Great Recession made investors who were already cautious even more hesitant to invest. But if you want your money to grow significantly, you need to diversify your investments and not just hold onto cash. In the past, you could slowly save up money over time and feel secure about your future. However, things are different now, and our financial stability depends on being smarter about how we handle our money. The challenge today is to overcome the instinct to hold onto all our money and find better ways to make it grow.
Misconception #5: One Account Is Enough
Diversifying your assets is a key principle in investing, and this applies to cash as well. If you prefer keeping all your money in money market accounts, it’s important to remember that no single account should exceed the FDIC-insured limit of $250,000. It’s quite common to find families or estates using multiple bank accounts to ensure their money is as protected as possible.
To implement this strategy, splitting your money into three different “buckets” can be helpful. These buckets represent short-term (one to three years), mid-term (four to ten years), and long-term (over ten years) goals. This method leads investors to a more logical way of considering how much money to save and for how long. For a more tactical approach, you can apply the same buckets and realistically assess your willingness to take on risk.
For long-term savings, it’s a good idea to consider other low-risk investment options such as annuities, life insurance policies, bonds, or Treasury bonds. There are numerous ways to allocate your total net worth to reduce the risk of losing value due to keeping too much money in cash.
Beyond money market accounts, there are other investment options that offer higher interest rates. If you’re comfortable with a bit more risk or if you want to have some funds available for the short and medium terms, there are funds and investment strategies that can offer the desired returns over time, considering both time and your tolerance for market ups and downs.
By adopting these strategies and keeping your money moving throughout different phases of your life, you can potentially outpace inflation and safeguard your money from losing its value. Ultimately, having a thorough understanding of these financial products will help you make the right choices for your individual circumstances.
What Is a Money Market Account?
A money market account is a deposit account offering higher interest than traditional checking or savings accounts. Money market accounts are offered by both banks and credit unions.
What Is the Downside of a Money Market Account?
The one possible downside of a money market account is that the institution may limit how many withdrawals you can make at a time, usually within a month or year, thus limiting access to your funds.
Is a Money Market Account Worth Having?
Whether or not a money market account is worth having will depend on the individual. But generally, yes, it is worth having. Money market accounts offer a low-risk environment with a higher interest rate to grow your money. Money market accounts are insured by the FDIC and can help individuals reach their short-term savings goals.
The Bottom Line
Money market accounts serve a singular purpose: To keep your money parked. Money, though, does nothing unless it is moved, and will ultimately require the investor to research their options and invest more diversely.
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