Money market account or money market fund?
October 16, 2012
Q: Would I do better in a money market fund or a money market bank account -- or is there really any difference?
A: Money market funds and money market accounts are more different than their names would suggest. Their similarity is that in theory, they are both supposed to be invested in very short-term fixed-income securities. However, the composition of the underlying investments matters a great deal more for money market funds, because they are essentially mutual funds where the return to the investor is determined by the performance of the securities the fund owns, minus the management fee charged by the fund. Money market accounts, on the other hand, are general obligations of the bank that offers them.
As for which would give you a better interest rate, that is something that would vary on a case-by-case basis. Both have variable interest rates, so the rate you sign up for might not be what you earn going forward. Perhaps the most meaningful difference, though, is that bank-issued money market accounts are backed by FDIC insurance, which means you stand virtually no risk of losing money as long as you don't deposit more than $250,000 in any one bank.
In contrast to the certainty of FDIC insurance, there are some proposed rule changes that would radically change the nature of money market funds. During the 2008 financial crisis, some money market funds were in danger of losing money, which could have had a devastating psychological effect on investors because people had come to assumed that money market funds were completely safe. To acknowledge the potential risk, the SEC Chairman has proposed that money market funds be required have a changeable market value like other mutual funds. This value would reflect the changes in the underlying value of the securities the fund holds, and thus in negative market conditions that value could reflect a loss.
The SEC Chairman has further proposed that withdrawals from money market funds should be limited, to prevent a mass exit from those funds during market panics. Essentially, these proposals would mean that money market funds would no longer have a stable value nor offer complete liquidity, which would take away two of the main characteristics that attract people to money market funds in the first place. Not surprisingly, the investment industry has vehemently objected to these proposals, and they are even controversial within the SEC.
The bottom line is that money market funds come with a bit more uncertainty than you might want from a supposedly safe investment. A money market account from an FDIC-insured bank may not offer you any more in the way of interest, but it will give you much more in the way of security.
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