Financial experts recommend that you keep at least three months’ worth of expenses in an emergency fund to help you manage your finances if something goes wrong. But where should you keep your shorter-term savings?
Since you want access to your money whenever you wish, investing it in stocks isn’t a good option because of the volatility — what if your portfolio loses value right when you need the money? On the other hand, a checking account isn’t the best option either. Sure, your money is accessible and safely insured by a bank or credit union, but there is a higher chance you might spend the money.
One way to get around these issues is to consider a money market account (MMA). With MMAs, you have access to your money immediately and may also get a higher payout on your savings. Here’s what you need to know about the advantages and disadvantages of MMAs.
How money market accounts work
When you open a money market account, the bank takes the money and invests it in places considered relatively safe, like treasury bonds or certificates of deposit (CDs). The yield you receive is still subject to economic factors, but you don’t have to worry about losing your money due to a bank failure. Here are some of the features of MMAs.
- FDIC-insured: The most important consideration when setting up an emergency fund is its safety. If you get a MMA from a bank, the account is insured up to $250,000 thanks to Federal Deposit Insurance Corporation (FDIC) insurance. That means if the bank goes out of business, you’ll still get your money back. However, it’s important to note that money market mutual funds are a different product and not insured. Before you open a money market account, make sure it really is a bank account and not a fund.
- Hybrid between savings and checking: These lesser-known accounts offer some of the best features of both savings and checking accounts. Like savings accounts, they can pay competitive yields. Like checking accounts, they may offer checks and debit cards. As a result, you can manage your money more easily than with a savings account. However, MMAs aren’t designed to be used like a checking account. Under the law, there are limits to how many times you can move money out of a money market account. Ditto of savings accounts.
What are the advantages of a money market account?
The accounts feature three important advantages that make them good options for emergency savings:
- FDIC insurance: With FDIC insurance you aren’t liable for the money if the bank fails. As a result, you know your money is safe when you get a MMA from a bank.
- Withdraw money immediately: Your MMA is liquid, so you can get the money whenever you wish, for any reason.
- Higher yields than many savings accounts: You can easily find a money market account that pays a higher yield than a savings account.
What are the disadvantages of a money market account?
Consider these factors when weighing your options:
- Balance requirements: While not all MMAs require high minimum balances, some do. For example, you might need a hefty initial deposit (at least $5,000 for some accounts) and you might need to maintain a certain minimum balance on an ongoing basis. If you fall below the account minimum, you might be subject to a fee.
- Lower yields than CDs: Money market accounts may have lower yields than what you would see with a CD. However, with most CDs, you’re subject to an early withdrawal penalty — something you don’t have to worry about with a money market account.
- Limits on withdrawals: Even though MMAs can come with debit cards and checkbooks, there are still limits to how many transactions you can make. Under the law, you can only make six withdrawals per month on these accounts.
Best uses for money market accounts
If you want to keep your shorter-term savings safe while earning some degree of payout, a money market account can be a good choice. Here are some of the best ways to use MMAs.
1. Emergency fund
The two main characteristics of an emergency fund are its liquidity and safety. A money market account fits the bill. It allows you to access cash quickly, while at the same time, offers you FDIC insurance when you open one from a bank. Plus, you can earn a competitive yield.
2. Tax payments
If you’re self-employed or a business owner, you might need to make regular tax payments. Keeping the money for taxes separate from the rest of your finances can help you stay on top of the situation and avoid penalties later. Keep money in an MMA for tax purposes. You can easily write a quarterly check for the associated payments without violating the transaction limits on your account.
Treat your MMA as a vacation fund. The money is separate from your other savings and safe in an FDIC-insured account, so you know you’ll have access to it later.
However, you might want to move the money into your regular checking account before you go on vacation to avoid worrying about withdrawal limits. Or, you could use a credit card to pay for your vacation expenses and then write one check from your MMA to pay off your balance.
If you’re making tuition payments for yourself or a child, keeping the money in a money market account might be a smart choice. You can save up money over time using the account, and then write a check when the tuition bill comes due. However, it’s also a good idea to compare MMAs with other options for college savings to see if something else might be better for your individual situation.
If you’re looking for an accessible account that earns a relatively high yield, a money market account can be a solid choice. You can earn a competitive rate for your shorter-term savings.
However, there are some drawbacks, and the yield received from an MMA might not beat rates offered on savings accounts. Carefully consider your own financial priorities to determine what type of account might work best for you.