In today's financial landscape, it can be difficult for inexperienced savers and investors to choose the right place for their money. The stock market, while potentially lucrative, can be highly volatile and always carries at least some level of risk. On the other hand, savings accounts, while very low-risk, have such low interest rates that they actually lose value over time to inflation. While both the stock market and savings accounts certainly have their place in a financial portfolio, it is important to seek out alternative options that might be a better fit whenever possible. One such option is a money market account.
What Is a Money Market?
According to Investopedia, "Money Market" is a term used to describe a specific subset of the overall financial market. It primarily consists of highly liquid and very low-risk investment tools, such as certificates of deposits(CDs), U.S. Treasury bills, municipal debt and other short-term investment vehicles and agreements. When you invest in a money market account, you typically are not investing directly in any of these specific instruments. Instead, you deposit your funds at a bank or other financial institution, which then uses your cash to purchase instruments in the money market.
Pros and Cons of Investing in the Money Market
Investing in the money market certainly has its benefits, but it is not for everyone: One of the best aspects of a money market account is the fact that there is very little risk involved. Since cash in the money market is primarily used for short-term agreements between large institutions (such as governments, large corporations and banks), the risk of loss is essentially negligible. In addition, money market accounts typically offer a higher interest rate than traditional savings accounts, which, when compounded over time, can add up to a significantly higher return on investment than simply holding on to cash or putting it into a savings account. Best of all, unlike CDs, money market accounts will usually allow the owner to pull cash out, although this can be limited to a certain number of times per month or per year.
On the other hand, there are some negatives associated with money market accounts as well. Perhaps the most significant is the fact that, unlike a typical savings account, money market accounts are not always insured by the FDIC. While the actual risk of losing money in a money market account is quite low, there is still some risk involved. It is important to weigh this risk when considering the difference in interest rates between a money market account and a savings account. Another consideration is the fact that, although interest rates for money market accounts tend to be higher than savings accounts, the difference is sometimes quite small.
Maximize Your Return by Investing in a High Yield Money Market
One way to overcome the sometimes underwhelming interest rates on money market accounts is to use a specialized high yield money market account. Some, but not all, financial institutions offer this alternative for those who want to take on more risk in exchange for a greater yield. Although every bank is different, one of the most common ways to increase your yield is by investing in commercial paper, which, while fairly safe, still comes with significantly more risk than a traditional money market or savings account.
Should I Invest in a Money Market Account?
Every situation is different, and you should always speak to a financial adviser before making any major financial decisions. That being said, money market accounts are a great short-term option for individuals who want to earn a higher interest rate than a traditional savings account and don't mind taking on a little bit of risk. In the long-term, however, money market accounts make less sense. If you are looking for a long-term place for your money, there are higher yields (and often lower risks) associated with CDs and other financial instruments.