Money Market Accounts vs. Money Market Funds

Depositors in money market accounts know that these are distinct from money market funds, but understandably, people tend to view the two as somewhat interchangeable types of investments. However, events of the past year or so have underscored why depositors in money market accounts enjoyed a smoother ride through the financial crisis than investors in money market funds.

A money market account is an individual account offered by a bank, which allows depositors short-term access to their money but with some restrictions. Money market funds, on the other hand, are a form of mutual fund. They are designed to provide stable value and liquidity, but again, there may be restrictions on the number of transfers you can make in and out of a money market fund.

In short, both money market accounts and money market funds are designed to be short-term, liquid, and stable. However, there are some important differences which have been made more prominent by the 2008-2009 financial crisis.

Pool of Resources

A money market account is backed by the general resources of the bank, whereas a money market fund is supported by a specific pool of investments. Those investments are designed to be conservative, but they can still go bad--and that's exactly what started to happen in late 2008, threatening the stability of some money market funds.

Money market account deposits offer banks more flexibility, which is why bank rates may exceed yields from their money market fund counterparts. Recently, when the highest money market funds available were offering yields of only around 0.5%, the best money market accounts listed on money-rates.com were yielding between 1.5% and 2%.

Impact of Other Investors

Another issue is the impact of other investors' behavior. Because a money market fund is a pooled account, your investments can be affected by the flow of money from other investors in and out of the fund. Ordinarily, this impact is negligible, especially in very large funds. However, in times of market turmoil, those inflows and outflows can become significant enough to make a difference.

Heavy flows into a fund can dilute the yield--there is always a little time involved in getting new inflows invested, during which time that new money is unproductive and drags down the overall yield. When money is flowing out of a fund at a rapid rate, it can create forced sales of the underlying securities under distressed circumstances, and that too can drag down the yield.

These are generally subtle influences, but given the low level of money market fund yields right now, they can be enough to make a difference.

Money market accounts, on the other hand, are individual accounts that are not directly affected by the actions of other depositors. In extreme circumstances, a run on the bank could endanger the solvency of that bank, but even that case leads us to one final important distinction between money market accounts and money market funds: the underlying guarantee.

Government Guarantee

Within FDIC insurance limits, money market accounts are backed by the federal government. Although the government stepped in temporarily to shore up money market funds during the crisis, this support has now expired, and money market funds do not enjoy full government backing.

For all their similarities, money market accounts and money market funds do differ--seemingly to the advantage of money market accounts.

Source:

Walter Updegrave • The risk of 'breaking the buck' • Sep 23, 2009 • http://money.cnn.com • http://money.cnn.com/2009/09/22/pf/expert/money_market_funds.moneymag/?postversion=2009092209 • CNNMoney.com

Retail Money Funds • http://www.imoneynet.com • http://www.imoneynet.com/retail-money-funds/index.aspx • iMoneyNet