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What is a money market account? Here are the basics

At a glance:

  • What is the money market? Here are the basics

  • What is a money market deposit account (MMDA)?

  • The types of MMDAs

  • How you can use MMDAs

  • How to use MMDAs in retirement planning

  • Summary of MMDAs

If you have ever come across the term "money market" at your bank or credit union, you may have just ignored it. Look again. These accounts are worth learning about, because they offer several advantages that are worth your time to know. Gone are the days when you needed $5,000 or $10,000 to open one.

Money market deposit accounts (MMDAs) have evolved to meet the demands of the marketplace by lowering their minimum deposit amounts, in some cases to below $1,000, and by expanding their uses to include retirement accounts. Individuals have responded with several uses of their own, from saving to buy a house, to saving their retirement payouts, and more.

Once largely a tool of big institutions and wealthy investors, money market deposit accounts are becoming more widely known and more accessible to individual investors just like you.

MMDAs are becoming more accessible to investors. (Photo: Kena Betancur/Getty Images)
MMDAs are becoming more accessible to investors. (Photo: Kena Betancur/Getty Images)

What is the money market? Here are the basics

The money market is a market where very short-term debt investments are bought and sold.

It allows both individuals and institutions to invest money into a liquid account that pays interest (dividends at a credit union). These earnings are typically higher than those of traditional savings accounts and are typically competitive with rates offered by certificates of deposit (called "certificate accounts" at credit unions).

Examples of the short-term investments found in the money market are money market deposit accounts, US Treasury bills, repurchase agreements, commercial paper, negotiable certificates of deposit (called credit union share certificates by credit unions), banker's acceptances, and money market mutual funds.

A money market mutual fund is simply a ready-made portfolio of short-term debt investments held by that mutual fund.

Money market mutual funds are not insured by either the Federal Deposit Insurance Corporation or the National Credit Union Administration.

How you can benefit from the money market

Normally, government bodies and large institutions invest in the money market to make reasonable returns on large sums of liquid cash. However, now individuals can access this market as well (though rarely directly). Many do so through money market mutual funds.

Others access it through money market deposit accounts (called money market accounts by credit unions), which are a type of savings account with some money market features. Both of these investments pool money from thousands of individuals and companies to buy money market securities on their behalf.

Most financial institutions offer money market deposit accounts, and many offer money market mutual funds and money market checking accounts as well.

What is a money market deposit account (MMDA)?

A money market deposit account (MMDA) is a type of savings account offered by financial institutions that pays interest or dividend rates that are higher than those offered by traditional savings and checking accounts, and competitive with certificates of deposit.

Credit unions generally call these instruments money market accounts. MMDAs are an indirect way to invest in the market for short-term money market securities, and their returns are tied to those of money market investments.

The minimum balance is fairly high

Most money market deposit accounts require a relatively high minimum balance to avoid fees. Minimums of $2,000, $5,000, or $10,000 are common; they can be as high as $50,000 or more at some institutions to get the best rates. A requirement for larger minimum balances can be a disadvantage for investors of limited means.

The demand for these accounts has grown significantly over the decades. In the competitive marketplace, some banks and credit unions have begun to offer money market deposit accounts for initial deposits as low as $1,000 or less, so it is wise to ask what low minimum balance options may be available to you.

Know the restrictions on them

Transactions into and out of MMDAs are subject to restrictions. Generally, a maximum of six withdrawals to third parties is allowed each month; of these, typically three may be with checks or debit cards. However, each institution is free to impose additional restrictions. This allows the institution greater discretion in how it invests funds, theoretically providing higher returns to accountholders.

Funds are insured

Funds deposited into MMDAs are insured by either the Federal Deposit Insurance Corporation (for banks) or the National Credit Union Administration (for federal credit unions and many state-chartered credit unions) for up to $250,000, and up to $250,000 if they are retirement accounts.

The types of MMDAs

Financial institutions make money market deposit accounts (MMDAs) available in many variations. They vary by the minimum deposit required, the maturity, the interest or dividend rates paid out, and how the earnings rates are determined.

A variety of names are used to describe MMDA accounts, for example, "money market plus account," "money market advantage account," "money market certificate," and similar terms.

Indexed MMDA rates are tied to the average yields of US Treasury bills.

Money market certificates and IRAs

Money market certificates are a hybrid of MMDAs and certificates of deposit. When they were first issued decades ago, they had a fixed maturity of six months and required a minimum deposit of $2,500. Interest or dividend rates were based on the average yields of US Treasury bills. This changed with the deregulation of the 1980s, and now each institution may set its own maturity, yield, and minimum deposit.

MMDAs used as individual retirement accounts are called money market IRAs. Because individual retirement account contributions and earnings may be tax-deductible or tax-deferred, these accounts have restrictions on when funds can be withdrawn.

How you can use MMDAs

If you have $5,000 or more sitting in a traditional checking account, can you earn more elsewhere and still have freedom to take the money out? With a money market deposit account (MMDA), you can.

If you are saving up for a new car and don't want to risk the volatility of the stock market, can you keep it in a low-risk account while it grows at a healthy rate? With MMDAs, you can.

MMDAs offer more liquidity than certificates of deposit, as well as higher yields than most traditional savings and checking accounts. The cost of this convenience is that they typically require that you keep more of your money invested in them.

As a result, they are popular with individuals and companies who have a large amount of money to park for relatively short periods.

Here are some examples of institutions and individuals who use money market deposit accounts:

  • Individuals who are saving up for a home, vacation, or other large purchase

  • Individuals maintaining emergency funds, such as two to three months of salary as a "cushion" to safeguard against medical costs, interruption in employment, etc.

  • Investors who are waiting for an opportune moment to buy stocks, mutual funds, or other investments that can fetch higher returns

  • Individuals who employ various formula investment plans, where they keep a certain amount in an MMDA and withdraw from it according to the formula to purchase stocks or mutual fund shares, or perhaps tangible investments such as metals

  • Individuals and institutions who want a safe place to park funds earned from selling off assets such as stock or a home

  • Individuals saving for retirement, either through standard MMDAs or MMDA IRAs

  • Individuals saving to pay tax bills or various expenses

  • Businesses investing surplus funds for short-term needs

  • Non-profit organizations saving their funds for eventual use

  • Government bodies investing their tax revenue

Their liquidity and competitive rates make MMDAs popular for a variety of uses, many of them short term and many of them long term. They have become a very useful part of many financial plans, both for individuals and for companies as well.

How to use MMDAs in retirement planning

Though many people don't associate money market deposit accounts (MMDA) with retirement planning, these accounts are useful for the temporary holding of funds for one's retired years.

Once you have the minimum amount required to open one (they vary according to the financial institution), you can use an MMDA for any of several retirement uses.

Some investors use them temporarily

You can use them to transition to a mutual fund or stock retirement account once you have built up a fairly large amount of money, perhaps $2,500 or $5,000. People do this with the expectation of earning higher returns elsewhere, though returns are never guaranteed.

During this time, their money will grow at a rate competitive with those of certificates of deposit. With money market individual retirement accounts (IRAs), this money can grow tax-deferred until it is rolled over to a different investment.

Some investors use them long-term

A few very conservative savers prefer to use an MMDA as a long-term retirement account. Sacrificing the higher anticipated return of many other investments for safety of principal, they keep their money in an MMDA for the duration of their working years and draw from it in retirement.

Because retirement MMDAs are insured for up to $250,000, they are attractive to some as a low-volatility vehicle for building funds over many years.

Others use them during retirement

Many retirees look for a convenient place to keep some or all of the money that they must withdraw from their tax-qualified 401k’s, IRAs, Keogh plans, and other such retirement accounts.

An MMDA is a popular place for many to store their newly withdrawn funds because of its liquidity and insurance features. Accountholders can withdraw funds without having to pay fees (unless they exceed the allowed monthly withdrawal limit).

Summary of MMDAs

If you like the traditional savings account, you may like the money market deposit account even more. You can earn a higher rate on it if you can abide by the restrictions on withdrawals. Plus, these accounts are insured. You can use them to store money that you may need for other purchases.

You can save up cash to invest in the stock market or buy a house. You can withdraw from your retirement account and keep the money safely. Or, you can save for retirement with the money market account itself.

MMDAs offer higher returns than traditional savings accounts, in return for larger deposits and some withdrawal restrictions. Many individuals who like the safety features of traditional savings accounts have found that MMDAs can fit their needs just as well or better.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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