When it comes to savings, money market accounts are among the most popular. They offer better returns than most standard savings accounts, yet still allow easy access to your money when you need it. These accounts are often confused with money market funds, but the two are actually very different.
Whereas a money market account is guaranteed not to lose value, there is no such guarantee with a money market fund. That’s because instead of a bank-backed savings account, a money market fund is an investment vehicle. Some banks offer money market funds as well as money market accounts, adding to the confusion.
One of the most attractive aspects of money market funds is that they carry much less risk than most investments. They are required by law to be comprised of numerous low-risk securities. These securities may include government bonds, CDs, and commercial paper from corporations, among others.
The idea behind a money market fund is to keep the value of each share at exactly $1. The yield, however, may rise and fall, and this determines how much the investor stands to gain. In some rare cases, however, money market funds have dropped below $1 per share, subjecting shareholders to losses.
As a general rule, money market funds are very safe. Since their inception in 1971, only three funds have lost money. But in an uncertain economy, anything is possible. So just like any other investment, it is prudent to choose money market funds wisely.
Types of Money Market Funds
Money market funds may be taxable or tax-free. Taxable funds require that investors pay income tax on any earnings made. Tax-free money market funds are not subject to federal taxes, and in some cases are also exempt from federal and local taxes.
General purpose funds are those that invest in a wide variety of securities. All investments made are highly rated, but at least part of them are non-government investments. These funds tend to have higher yields, but they are subject to a greater amount of risk.
Government funds invest only in securities from the federal government. This provides a lower level of risk, but yields are usually lower as well. Some government money market funds invest only in U.S. Treasury bonds. Others add investments in Ginnie Mae and Freddie Mac bonds to the mix.
If you’re looking for a risk-free way to earn a return on your money, a savings account or CD is probably your best bet. But if you can tolerate a small amount of risk, a money market fund has the potential to increase your earnings. While you probably won’t get rich with it, you can get a better rate than most bank accounts can offer.