Money Market Funds vs. High Yield Savings Accounts: 4 Key Differences
- Consumers looking to earn high interest on their savings while retaining easy access to their money are often torn between high-yield savings accounts and money market funds.
- “They are very safe and provide liquidity,” said Greg McBride, chief financial analyst at Bankrate.
- However, there are major differences in terms of risks, taxes, returns and more.
When it comes to earning a decent return on their savings, consumers may wonder: Should I go for a money market fund or a high-yield savings account?
The purpose of both of them is similar. Generally, these funds act as repositories of emergency funds or short-term savings, perhaps for a car or house or for a vacation, said Camilla Elliott, a certified financial planner and CEO of Collective Wealth Partners, based in Atlanta.
That’s because money market funds and high-yield savings accounts are stable and allow for easy access — two essential features when saving money you can’t afford to lose and might need in an emergency, said Elliott, a member of the CNBC board of advisors. .
“They are very safe and provide liquidity,” said Greg McBride, chief financial analyst at Bankrate.
In addition, their returns are often higher than those of traditional bank savings accounts. They have risen sharply over the past year and a half as the Federal Reserve has increased its benchmark interest rate to tame inflation. Many are paying yields above 4% and 5% after years of sitting near rock bottom.
By comparison, traditional savings accounts pay a paltry 0.54% on average, as of August 28, according to Bankrate.
Consumers do not necessarily have to make an either-or choice.
“A lot of investors have both,” McBride said.
Here are some of the main differences.
High-yield savings accounts are bank accounts, often offered by online institutions.
This means that they carry Federal Deposit Insurance Corporation (FDIC) insurance. This government-backed coverage insures bank deposits of up to $250,000 per account.
On the other hand, experts said that money market funds – while generally safe – are a bit riskier.
They are investments in mutual funds, offered by brokers and asset managers. Funds typically hold safe, short-term securities, which, depending on the fund, might be US Treasury bonds or high-quality corporate debt, for example.
The funds aim to maintain a fixed price of $1 per share. Only a handful of times in history have money funds “broken the dollar” – perhaps most notably during the 2008 financial crisis, when the share price of the primary reserve fund plunged to 97 cents, owing to the bankruptcy of Lehman Brothers.
From 2007 to 2011, at least 21 other funds had managed to succeed without an injection of capital from fund sponsors, according to a 2012 report from the Federal Reserve Bank of Boston.
Because they are not bank accounts, money boxes do not carry FDIC insurance. They have the protection of the Securities Investor Protection Corporation, or SIPC, which insures against the loss of cash and securities of up to $500,000 in the event of an investor’s mediation failure. However, CIBC does not protect against investment loss – it takes back clients’ property during the liquidation process but does not recover value if there is a decline.
Elliott said that investors who prefer money market funds may choose government money market funds, which carry slightly less risk. These companies are largely invested in US government debt – that is, Treasury bills – rather than in corporate debt.
Elliott said money market funds tend to pay a slightly higher interest rate compared to higher-yield savings accounts.
The highest-yielding money funds currently pay 5.4% to 5.5%, according to Crane Data. (This return is measured as the fund’s seven-day average annual return. It is net of investment fees, which reduce the return.)
Currently, high-yield savings accounts pay up to 5.25%, McBride said.
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While each tends to track movements in the Federal Reserve’s benchmark interest rate, their returns rise for different reasons. Experts said the underlying investments in money market funds are directly affected by the Fed, but banks tend to increase payments to attract more customer deposits – which they then lend out to make money. Higher rates generally attract more deposits.
McBride said the current rates are just “a snippet of time”. From 2008 to 2021, he said, high-yield accounts were “much higher than what money funds pay”.
It is not clear how long rates will remain this high. Some forecasters believe that the Fed will start cutting interest rates next year.
High-yield savings accounts generally don’t have a minimum deposit requirement — and if they do, it’s a relatively small amount, McBride said.
He said that money funds tend to require a minimum investment of more than $1,000.
“This is not necessarily a hurdle that everyone can cross,” McBride said. He added that consumers want to be careful about allowing their credit to go below a certain level and incurring fees.
Experts said interest income for both high-yield savings and money funds is taxed as regular income. These rates are as high as 37% at the federal level.
However, Eric Brunikant, Betterment’s head of taxation, said some money market funds may carry tax advantages. He said it was important for consumers to take into account their net income after taxes.
Specifically, Bruninkant said interest income from funds holding US Treasury securities may receive an exemption from state and local — but not federal — taxes.
In general, he said, states allow investors to prorate the portion of income related to US government debt. For example, for a monetary fund holding 25% of Treasury bonds and 75% of commercial debt, 25% of the investment would be exempt from state and local taxes.
(There are exceptions: California, Connecticut and New York require at least half of the fund’s assets to be invested in US government bonds to qualify for a tax break, Bruninkant said.)
Separately, asset managers also offer municipal money market funds, which invest in tax-exempt municipal securities — but generally come with a lower return, McBride said.
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