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Where to keep your rainy day fund

Even if your rainy day fund is small, it's big enough to deserve the best account you can find to keep it in. Often, a money market account, or MMA, will do the trick, but there are also high-yield money market accounts, high-yield savings accounts and money market mutual funds -- or money funds -- to consider.

Whether you're saving for emergencies or an upcoming purchase, you want this money to be liquid and you want convenience when making deposits and withdrawals. One drawback with high-yield accounts is that you may have to go online to open one. While millions of Americans are overcoming their phobia about this, many people still aren't comfortable plunking their cash in an online bank with no chance for face-to-face interaction with bank personnel.

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Money market accounts are souped-up savings accounts that, generally, give you the ability to write a limited number of checks against the account each month. You can open one at just about any bank or credit union and your deposits are insured up to $100,000 by the Federal Deposit Insurance Corp. or the National Credit Union Association. As of April 2006, if you open a retirement account, your deposits are insured up to $250,000 by the FDIC. The average interest rate is around 2.16 percent at a bank and about 1.5 percent at a credit union. That's about double what you'd get in a regular savings account.

By comparison, a high-yield money market account is like a savings account on steroids. As mentioned, it can be difficult finding one at your neighborhood bank. But going online to open an account may be well worth the effort because you'll easily find accounts paying 3 percent or better.

High-yield savings accounts don't have the check-writing feature. Capital One, for example has a high-yield savings account that pays the same yield as its high-yield MMA. It doesn't offer check-writing, but requires only $1 to open vs. $100 for the MMA.

Some high-yield savings accounts, such as ING Direct, link to your existing checking account so you can transfer money between accounts and write checks.

Money market funds, or MMFs, are mutual funds that you can purchase through a brokerage or a fund family such as Vanguard, Fidelity or anywhere else that sells investment products. There is no FDIC coverage, but the funds are strictly regulated and no investor has yet lost any principal. Traditionally, the funds are linked to a brokerage account to hold cash from the sale of stocks or bonds, and the money is readily accessible when you decide to buy additional stocks or bonds. But many people, perhaps because of the convenience of having all their accounts in one place, use MMFs for longer-term savings goals.

Money market funds are divided into two categories, taxable and tax-free. Taxable funds usually pay a higher yield, but that doesn't always make them the better deal. If you're weighing a taxable fund against a tax-free fund, you'll need to do some math called the tax-equivalent yield formula to see which will give you the better return.

You can find many MMFs with a seven-day yield of approximately 2.80 percent. A seven-day yield is an annual yield that is based on the preceding seven days' level of income by the fund. That 2.80 percent is far better than the plain vanilla MMAs, but lower than the high-yield MMAs and high-yield savings accounts.

Scott Hintz, assistant vice president of securities at State Farm, says there are philosophical differences between MMAs and MMFs.

"Structurally, they look, feel and act the same, but the bank's objective is to get deposits and then turn that money around and make loans. There's an expense to run a MMA, but they'll charge account holders the bare minimum. From a money-fund perspective, the name of the game is assets under management so we can earn the asset-management fee. We don't turn the money around and make loans; we don't manage a MMF at cost, we charge an expense ratio."

While you won't see a fee or expense ratio listed for a MMA, Hintz says costs have been calculated in the yield.

Money market accounts and funds invest in ultra short-term securities. The yields are sensitive to Fed rate hikes and cuts.

"In a money market, you have overnight investments and you have investments with 60- to 90-day maturities, so some elements will reflect changes in the fed funds rate immediately and others not until those investments mature," Hintz says.

Money market accounts advertise an annual yield. That's what you'll receive provided you leave your money in the account for a full year. Some money market and high-yield savings accounts have a tiered system for receiving that top yield. You may have to deposit $25,000 or even $50,000 to get the best deal.

MetLife's MMA and its high-yield savings account pay 3.0 percent on balances of $5,000 or more, but if your balance is below $5,000, you'll only earn 1.0 percent. Compare that to ING Direct , currently paying at least 3.0 percent on all balances, and requiring just $1 to open an account.

Money funds advertise their seven-day average yield. By looking at the year-to-date yield, you'll clearly see the current interest rate trend. For instance, Fidelity's Select Money Market Portfolio has a year-to-date yield of 1.21 percent, while its seven-day yield is 2.96 percent.

"It gives an indication of how fast things can happen in money funds," says David Bohannon, CFP, in Louisville, Ky. "Interest rates can change virtually daily -- up or down."

Kim McCann, senior manager at Allstate, says the seven-day yield is more important than the fund's average annual returns over the past three, five or 10 years.

"It doesn't do much good to know what the fund did over the past 10 years. It's more important to see what's happened over the past seven days. See if there's an upward trend."

Check writing
Most money fund and money market accounts allow you to write checks. While you can make unlimited withdrawals by ATM if there's a card attached to your account, you may be limited in how many checking, point-of-sale and electronic transfer transactions you can do each month.

Minimum to open and minimum balance
Both MMFs and MMAs have a wide range when it comes to the minimum amount of money needed to open an account. While some MMAs let you deposit as little as $1, most MMFs require at least $250 to open. Both also can get quite pricey and out of the realm of most depositors. You'll have to pony up $20,000 to buy shares in the Spartan Money Market Fund, and Chicago's Corus Bank wants $10,000 to open its high-yield money market account.

Watch out for accounts that assess a monthly fee if you don't maintain a minimum balance.

The main fees associated with a money fund are the expense ratio, transaction costs, low balance fees and sometimes a fee that is charged if you sell your shares before a specified amount of time. Some funds also charge a 12b-1 fee for marketing and distribution. Check the prospectus; money funds are required to show the effect of expenses on a hypothetical balance over various periods of time -- one year, three years, five years and 10 years.

Vanguard is known for low expense ratios, often 0.30 percent or less, but it's not uncommon to find some fund companies charging close to 1 percent for a money market fund. Why pay that? Is the yield that much better? Probably not.

Perhaps the most common money market account fee is for a low balance. For instance, Everbank charges $4.95 monthly if your balance slips below $1,500. MetLife charges $15 if you don't keep a minimum balance of $1,500. Ouch! But you may also find fees for returned deposits, closing an account early, nonsufficient funds, requesting a paper copy of your statement and just about every other fee you find associated with a checking account. You should also check to see if there are debit card fees if your account has one.

When it comes to money market accounts and funds, fees are critical. Fees cut into the interest you receive. Inflation also needs to be considered. If inflation is 2 percent and you're getting 0.50 percent interest, the purchasing power of your savings is eroding. You're making the effort to save, so take a little extra time to find the account that's right for your goals.


-- Updated: July 5, 2005


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