Money Market Accounts: Ideal for Emergency Funds

By Miranda Marquit on 12 June 2013 (Updated 8 July 2014) 1 comment

In this low-rate environment, many savers are looking for ways to get a little more bang for their savings buck. While you aren't going to see dramatic returns from any cash product, one way to boost your yield a little bit is to use a money market account. (See also: Why Savings Account Interest Rates Are So Low)

What Is a Money Market Bank Account?

A money market bank account is a deposit account. The yield is based on the current money market rates, which are set in the "money markets," where super-safe investments such as government or corporate bonds are traded. As a result, the interest rate is usually little higher than what you would find with a "regular" savings account.

Your money market account is considered a savings account (even if your account comes with check writing privileges), so it is subject to all the same rules associated with savings accounts. The Federal Reserve's Regulation D sets forth the rules for withdrawing from accounts that are considered "non-transaction." A money market account fits this description; you are only allowed up to six withdrawals a month, and only three of those can be via check.

Because a money market account comes with limited checking writing abilities, and because of the competitive interest rate, it can be an ideal place to keep your emergency fund.

What Isn't a Money Market Account?

Don't confuse a money market bank account with a money market mutual fund (more on these investments later).

Money market bank accounts and money market mutual funds are two completely different financial products. A money market bank account is an account set up through your banking institution and can be FDIC insured. A money market mutual fund, on the other hand, is an investment product that is not FDIC insured. Your capital is safe with a money market bank account; there is the potential for loss with a money market mutual fund.

Make sure you understand the difference before you commit your money.

What to Expect With a Money Market Account

In many cases, a money market bank account requires a higher initial deposit than regular savings accounts. It's common to provide an initial deposit of $1,500 or $2,500 to open a money market account. Additionally, you might have to maintain a higher minimum balance to avoid penalties and fees with a money market account. It is not unusual to find a money market account with a $2,500 or $5,000 minimum balance.

Realize, too, that because federal regulations limit your monthly withdrawals, you could be subject to fees for exceeding the maximum number of monthly withdrawals — or even have your account closed immediately and all of the money transferred to an account with a lower yield. Some banks purposely put lower limits on your withdrawals in order to prevent you exceeding the six allowed by regulations. Double check bank policy before opening your account.

If you put your cash into a money market account, be prepared to keep it in there for middle to long term purposes. A money market account shouldn't be used as a regular transactional account, and you shouldn't expect particularly high returns (unless rates go up over time).

Who Should Use a Money Market Account?

The nature of the money market bank account makes it a decent choice for an emergency fund. With a competitive interest rate, it can provide you with some yield while you keep your money against an unexpected event.

A longer-term CD offers higher yields, but the price of accessing your money before the end of the term can be too high. A money market account allows you instant access to your money; you can even write a check or access your account via debit/ATM card.

If a "regular" or online savings account isn't providing you with the yield you want (or the easy access that comes with check writing privileges), a money market bank account can offer you a slightly better deal. Just be aware that a money market account, like most cash products, comes with interest rate risk. Even the highest yield might not be enough to beat inflation, which means that you could see real losses in terms of buying power over time.

What About the Money Market Mutual Fund?

If you are a little more daring, you can consider a money market mutual fund. These mutual funds rely on "like cash" products, like short-term corporate debt, to provide returns. For years, these funds were considered almost as safe as savings accounts. However, following the financial crisis of 2008, some funds actually lost money — something unheard of before. Prior to the financial crisis, money market mutual funds were considered among the safest of investments.

Money market mutual funds are still considered fairly safe. They offer reasonable returns (for "less risky" investments), and some money market funds will even allow you to write checks in order to access the money in the account. Some consumers find money market mutual funds attractive for emergency funds as a result.

However, your investment isn't guaranteed with money market mutual fund; you could lose your capital to more than just inflation. On top of that, you will want to watch for the implementation of new rules governing money market accounts. For the past few years, regulators have been trying to find a way to prevent a debacle like 2008, and the SEC is proposing new rules for money market mutual funds. You'll want to stay on top of potential changes so you can adjust your strategy accordingly.

Bottom Line

The money market account is a nice compromise between the yield that comes with a CD and the flexibility that comes with a more accessible account. It's in that "just right" that can make it an ideal emergency fund. And if you can handle a little more risk, there is the money market mutual fund, which can add a little oomph in terms of yield, and might even have check-writing privileges. Just be aware that your money isn't FDIC insured in a money market mutual fund.

Do you have your money in a money market savings or mutual fund account?

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With yields so puny, why take on any risk? The incremental return is not worth it. The best MM accounts are online. Last week I say some as high as .9 or maybe even more than that. But in any event, having a cash reserve is so important these days and yield is almost a secondary consideration.