Understanding Money Market Accounts: A Comprehensive Guide

When it comes to managing your finances, it’s essential to understand the various types of accounts available to you. While checking accounts are designed for daily transactions and paying bills, savings accounts are meant to hold your cash reserves. A money market account blends features of both and can help you earn interest on savings you don’t need right away. This article will explore how money market accounts work, their pros and cons, and when they might make sense for you.

What Is a Money Market Account?

A money market account allows you to earn interest on your savings, making it a great place to park your emergency fund or other cash reserves. You can also write checks from the account, and some money market accounts even come with a debit card. Interest rates are usually variable, with interest compounding at predetermined intervals; that might be daily, monthly, or annually. Another draw is that money market accounts typically pay higher interest rates when compared with traditional savings accounts.

Benefits of a Money Market Account

Higher Interest Rates

One of the biggest benefits of a money market account is that interest rates are usually competitive. At the time of this writing, some financial institutions offer annual percentage yields (APYs) as high as 4.55%. That works out to $45.50 for every $1,000 in the account. The average rate on a traditional savings account is just 0.35%, according to the Federal Deposit Insurance Corporation (FDIC).

Full Access to Your Money

Some investments make it difficult to tap your funds. Certificates of deposit (CDs), for example, require you to keep your money locked up in the account for a predetermined amount of time. You’ll likely be penalized if you withdraw funds before the maturity date. Retirement accounts like 401(k)s and traditional IRAs have penalties of their own. Dipping into these accounts before age 59½ usually triggers a 10% fee on top of taxes. A money market account, on the other hand, offers much more liquidity. You can access your funds whenever you like.

Low-Risk Investment

Unlike individual stocks and other volatile assets, a money market account is seen as a low-risk investment. Interest rates are typically linked to the federal funds rate set by the Federal Reserve. When the Fed authorizes rate hikes, yields on money market accounts, savings accounts, and CDs tend to go up too. That can make money market accounts an attractive investment when interest rates are on the rise, especially amid inflation.

Disadvantages of a Money Market Account

Lower Returns Compared to Other Investments

Investing is all about netting potential returns. While a money market account is considered a safe investment, returns tend to lag behind higher-risk assets. Over the past century, the average annual stock market return has been almost 10%. That’s not to say it’s all smooth sailing or that stock returns are guaranteed. When it comes to stock investing, market volatility comes with the territory.

This is precisely why maintaining a diversified portfolio is so important. The idea is to include a variety of high- and low-risk investments across different asset classes. That can help mitigate risk while still exposing you to some high-return investments.

Limited Withdrawals

One of the biggest disadvantages of a money market account is that some financial institutions may put a cap on how many convenient withdrawals you can make each month. The Federal Reserve once limited consumers to six per month, though this rule was phased out in 2020. That excluded ATM withdrawals but did include electronic transfers, as well as debit and check transactions. Some financial institutions have continued to uphold these rules, so be sure you understand any limitations before opening a money market account.

Minimum Balance Requirements

Some high-yield money market accounts require minimum opening deposits and have minimum balance requirements. Failing to maintain that minimum balance could result in fees for the account holder. If you’re just beginning to build your savings, you might want to research money market accounts that don’t have these mandates. You can always switch to a higher-yield money market account once your balance is large enough to qualify.

What Are Money Market Accounts Good For?

A money market account can be a great holding place for your emergency fund or other cash savings. And thanks to their typically higher interest rates, your money can work a little harder for you. Just be on the lookout for fees and restrictions, as every financial institution is different.

Money market accounts generally earn less than higher-risk investments, so they’re probably not ideal for retirement savings. However, they may be good for holding a portion of your cash savings for easy access. The following savings goals might be a good fit for a money market account:

• Building your emergency fund
• Saving for a big-ticket purchase
• Putting money aside for a down payment on a house
• Growing your travel fund

Alternatives to Money Market Accounts

A money market account isn’t always the best option. You might also consider one of the following:

Certificates of Deposit (CDs)

It isn’t as easy to access funds in a CD, but you may land a higher interest rate. That can make sense if you don’t mind sacrificing liquidity for a while. At the time of this writing, some CDs offer rates as high as 5%.

High-Yield Savings Accounts

Interest rates on high-yield savings accounts are typically higher than traditional savings accounts. They’re mostly offered by online banks, so ATM access may be limited. However, you can link your checking account to your savings account and make transfers as needed. Just be aware that monthly transfers may be limited.

The Bottom Line

A money market account can be a great place to keep some of your cash savings. That can include your emergency fund or money you’re setting aside for other financial goals. Interest rates tend to be higher when compared with traditional savings accounts, and liquidity isn’t an issue.

Having cash on hand is a key part of financial wellness. The same can be said about your credit health. That’s why Experian offers resources like free credit monitoring to help consumers reach their credit goals.

If you’re looking for expert advice on managing your finances, O1ne Mortgage is here to help. Call us at 213-732-3074 for any mortgage service needs. Our team of professionals is ready to assist you in making the best financial decisions for your future.