Saving money for the future is an essential part of building a strong financial foundation. So is stashing cash in an account that pays a decent interest rate and is easy to access if you need it. Once you’re in a position to save, the next hurdle is figuring out where to put your cash.
The good news is there are several options available, depending on your specific needs and situation.
Three of the most common (and often safest) accounts available for saving for an emergency, an upcoming purchase or a rainy day are money market accounts, savings accounts and CDs. Understanding the differences between these interest-bearing accounts can help you make the best choice.
First, though, you might be wondering about money market accounts. Many savers know about savings accounts and CDs, but may be less familiar with money market products. In fact, the question, ‘what is a money market account?’ is searched online more than 12,000 times each month by people looking for the definition, according to Capital One. Here’s what you need to know.
What is a money market account?
At its basic level, a money market account is a savings product. However, it differs from a savings account (certificate of deposit, or CD) because you can usually write checks from it. Savings accounts and CDs don’t usually allow you to write checks.
However, a money market account is still considered a deposit account by the Federal Reserve’s Regulation D, so the number of transactional items, like transfers or withdrawals, is limited to six per month. Luckily, though, there are some transactions, including withdrawing from an ATM or bank teller, that don’t count as one of those six transactions.
Perhaps more important for savers looking for a better return on their money, with a money market account, you can expect to receive a higher APY than a traditional savings account. However, be prepared for a higher minimum balance and maybe some other requirements to make up for it.
How does a money market account differ from a savings account or CD?
All three of these accounts are deposit accounts, and if they are held at FDIC-insured banks or credit unions, your money is protected. However, there are some important differences between money market accounts, savings accounts and CDs.
First of all, a money market account usually comes with check writing privileges.
“Most savings accounts and CDs don’t allow you to write checks,” says Tom Drake, a financial analyst and founder of the money education website MapleMoney. “A money market account usually lets you write a limited number of checks per month, and you might even get a debit card.”
A money market account also usually has a higher APY than a savings account, although it probably won’t match the APY offered by a CD. Savers can now earn as much as 2.50 percent on a money market account, according to Bankrate, versus an average yield of just 0.1 percent on a savings account. Some two-year CDs now pay as much as 2.85 percent.
This higher return, explains Drake, is because a money market account usually requires a higher minimum balance than a savings account. However, unlike CDs, money market accounts don’t require you to keep your money in the account for a set period of time to earn the higher rate.
“The locked in nature of a CD usually means a higher yield than what you’d see with a savings account or a money market account,” Drake says.
Pros and cons of money market accounts, savings accounts and CDs
In order to compare these products, it’s important to understand their advantages and disadvantages. Here’s what you need to know.
Money market accounts
In general, money market accounts pay a higher APY than savings accounts. Check to see how your financial institution compounds the interest. You’re likely to see daily compounding, with the interest paid out monthly. Additionally, check to see whether the APYs are tiered. Often, you’ll have a lower APY until you reach a certain balance — then the APY increases. A balance of $100,000 or more, for example, will earn you a higher interest rate than an account with less than $10,000.
- Higher interest: Compared with many savings accounts, you can expect a higher rate of interest. The APY is also much higher than an interest checking account, which now sport an average yield of just 0.08 percent, according to Bankrate.
- Easier to complete certain transactions: A money market account comes with check writing privileges and the ability to easily make electronic transfers.
- Safe place for your money: Look for an FDIC-insured account so you know your money is protected.
- Limited withdrawals: Unlike a checking account, which doesn’t limit any types of transactions, you have limits on money market accounts. You can’t write unlimited checks or make unlimited electronic transfers.
- Account minimums: You’re often required to keep a higher account minimum than with a savings account, or even a CD.
- Monthly fees: If you don’t meet the account minimum, there’s a good chance you’ll be charged a monthly fee.
You can often find savings accounts with no minimum balance requirement that pay between 1 percent and 2 percent APY. Some savings accounts do require minimum balances, but they’re often much lower than a money market account. Like a money market account, though, your withdrawals are limited.
- Safe place for your money: Savings accounts are usually FDIC-insured and highly liquid.
- Low fees and minimums: It’s possible to find high-yield savings accounts that charge no minimums or monthly fees.
- Access ATMs: You can usually access your savings account via ATMs, making it convenient to get money when you need it.
- Much lower interest rates: Your APY on a savings account will probably be much lower than what you’d earn on a money market account or a CD.
- Withdrawal limits: The number of withdrawals you can make a month are limited.
Certificates of deposit (CDs)
A CD is the most restrictive of these savings accounts. You usually need to commit a minimum amount of money, and you have to lock the money away for a set period of time, such as three months, one year or five years. If you withdraw the money before the CD “matures,” however, you could end up paying a penalty. Depending on the size of the CD and the amount you put in it, you might earn a higher APY than you would with either a savings account or money market account.
- Interest rate: Not only is the interest rate on a CD often higher than other savings accounts, it is fixed and doesn’t vary over the term, like you see with money market and savings accounts.
- No fees: As long as you don’t withdraw your money early, you won’t be hit with any fees.
- Ability to choose your term: It’s possible to choose how long a term you want.
- Low liquidity and access: You can’t access your CD through an ATM or by writing checks. The money is also illiquid unless you’re willing to make an early withdrawal and pay the penalty.
- Penalties: While there are some CDs that allow you to withdraw some of the money without penalty, these typically come with lower APYs and other restrictions. If you don’t adhere to the requirements, you’ll pay a penalty.
Comparing account features
Here’s a helpful comparison of account features. You can see the differences between different types of accounts you might see at a bank or credit union.
Who should get a money market, savings account or CD?
Deciding which type of account to get depends on your goals and your current financial situation. If you don’t have a lot of money to start with, a savings account can make the most sense because it’s possible to find accounts that don’t require minimums.
On the other hand, if you want to earn a higher APY and you can meet a higher account minimum, a money market account can be a good choice. This is especially true if you still want access to the account without the potential early withdrawal penalties that comes with a CD.
If you know that you won’t need the money for a while, and you want to earn an even higher APY, a CD can work well. However, you should only commit money that you know you won’t need until the end of the CD’s term, because you don’t want to be subject to penalties.
How to use money market, savings and CDs to save for your goals
Each of these accounts can help you save for different types of goals, according to Drake.
“It’s not a situation where you have to choose only one account,” says Drake. “It’s possible to use these accounts together to manage different goals and maximize your yield.”
For short-term goals, Drake suggests using a savings account. You don’t earn much interest, but if you’re going to need the money soon, that won’t matter all that much.
A money market account can be well-suited for medium-term goals, he points out. “Because they have a higher minimum and pay a higher yield, you can get some benefit out of keeping the money in a money market account,” Drake says. “Plus, there’s enough liquidity that if something comes up, you can still access the money without worrying about penalties.”
Finally, CDs make sense for those who have long-term savings goals — especially if you have a relatively large amount of money that you can afford to have locked away for a longer period of time.
“If you’re looking at five to seven years for the money, a CD can be a good choice,” says Drake. “That money is protected by the FDIC, and you’ll earn a better yield on it. Plus, you lock in that interest rate, so even if the Fed cuts rates, you still get the same earnings.”
Risks of using money market accounts, savings accounts and CDs
While your money is protected by FDIC insurance from bank failures (and NCUA insurance from credit union failures), there are other risks to keep in mind as you consider these accounts.
The biggest risk you’re likely to run into is inflation risk. As consumer prices increase, your yield may not keep up with inflation. While you’re not going to lose your principal, you could see an erosion of your purchasing power over time.
Additionally, warns Drake, some accounts are more sensitive to the macroeconomic environment. “Savings accounts and money market accounts have yields based on Federal Reserve policy,” he says. “When rates drop, so does your yield.”
With a CD, you have some protection from those changes because you lock in the rate for the length of the CD. However, if the CD matures in a lower-rate environment, if you renew, you’re stuck with a lower yield than you had before.
“Make sure you have other money in investments to help offset the inflation risk,” Drake says. “Any type of cash account should be part of a bigger financial plan that also includes other assets like stocks and bonds.”
How to choose the right account for you
Ultimately, the account you choose depends on your current situation and on your cash and income needs. Take a look at where you stand right now. In many cases, it makes sense to start with a savings account. You can avoid minimums and fees and build your balance.
Over time, you might add a money market account and even CDs. At some point, when your savings account gets large enough that you’re not served by having so much money earning such a low yield, it’s time to branch out. A money market account can help you put that money to better use without the restrictions of a CD.
In the end, it’s about what you hope to accomplish with your money, and the combination of accounts most likely to help you reach your goals.