How Does a Money Market Account Work

If you're too risk-averse to invest in stocks, bonds or mutual funds, consider a money market account: a federally insured bank account that will pay you up to twice as much in interest as a regular savings account. This page answers the question, how does a money market account work? It also explains the benefits and drawbacks of opening one.

Introduction

Let's say you've got some money, but not so much that the interest rate on your savings account is racking up impressive returns. Let's also suppose you're not a gambler by nature—you don't want to risk sinking it all into stocks, bonds mutual funds, or anything that could end up dead in the water after a market crash. There is a way for you to more-or-less "invest" with practically no risk attached: open a money market account.

- Money market accounts are not to be confused with money market funds. A money market fund is a kind of mutual fund. For information on mutual funds, see how do mutual funds work.

How it Works

You can open a money market account at your local bank. (Creative Commons photo by dave mcmt)

Calling a money market account an investment actually makes it sound sexier than it is. A money market account is essentially a savings account that pays higher interest and includes the ability to write checks.

Money market accounts can be opened at banks or credit unions.
Money market accounts do involve investments, but you're not the one doing the investing. When you deposit money in a MMA, the bank invests it in the money market.
- The money market is a global market for short-term loans between governments, corporations, banks, and other financial institutions.
Money market accounts pay you monthly dividends, with compound interest.
- In other words, every day of the month, the interest you earn is reinvested into your account, earning even more interest.
- You are paid the full amount of the monthly interest at the end of the month.
Like regular savings accounts, money market accounts are insured by the government.
- Accounts opened at banks are insured by the FDIC (Federal Deposit Insurance Corporation).
- Accounts opened at credit unions are covered by the NCUA (National Credit Union Administration).
Unless there's an unprecedented market collapse, socialist revolution, or apocalypse, you have no risk of losing your money.

Benefits

Money market accounts can give you better interest than savings accounts and better security than investments.

Compared to stocks, bonds or virtually any other kind of investment, money market accounts are remarkably secure.
Unlike stocks and bonds, MMAs are also highly liquid: allowing you the freedom to withdraw money on short notice.
They earn more in interest than the typical savings account—sometimes twice as much.
Unlike regular savings accounts, MMAs allow you the convenience of writing checks, so you get some of the flexibility of a checking account with a better interest rate than a savings account.

Drawbacks

Money market accounts are extremely secure: more so than an old-fashioned bank vault, because they're federally insured. (Creative Commons photo by Daniel Leininger)

Low-risk generally means low yield and money market accounts are no exception to this rule.

- You're likely to earn far less in interest than you'd make investing the same amount of money in certain kinds of mutual funds, which are also relatively safe.
Many MMAs require that you maintain a minimum balance—anywhere from $1,000 to $50,000.
- If you can't maintain the minimum, you could end up losing more in fees than you gain in interest.
- Some online providers offer money market funds without a minimum balance.
MMAs don't quite replace checking accounts: many allow you to write only three checks per month.

Conclusion

A money market account probably won't make you rich, but they can provide a secure place for your money and a steady stream of interest payments. If you don't have the stomach for investment, an MMA could be just the thing.