How Money Markets Work

Money market accounts are a staple among those who want the most flexibility but the highest returns on their risk-capital. However, to understand how money markets work, we have to understand that there are actually two different types of money markets.

The first kind of money market is the money market account. This kind of product is found most often in a bank, and it is generally the favored type of money market because it is invested into very low-risk assets, and thus maintains FDIC protection of up to $250,000. The second kind of money market is the money market fund, which is an investment fund that is structured like an account, but often includes riskier, but higher yielding assets.

While the money market fund is still on the low-end of the risk chart, it is higher risk than a money market account, but makes up for the difference with higher yields. Understand also that money market funds are not insured by the FDIC, as they hold securities that are not consistent with bank accounts. At typical money market fund may hold US Treasuries, Agency debt, municipal bonds, or local municipal debt as a combined portfolio, or individually as specially marketed money market funds. While banks sometimes offer money market funds, these products are more likely to be found in financial planning offices or at brokerage firms as investment vehicles, not necessarily as savings vehicles.

How Money Markets Work
While they may hold different assets, they work in very much the same way. A bank or institution that manages a money market will take the funds and invest the majority of them in high-yielding, short-term investment vehicles like Treasury bonds, or the funds will be used within the bank as a “float” that allows the bank to make short-term, overnight loans to itself and other banks. This float is to the banking system what automotive oil is to an engine; while the bank can run without a float, the lubrication of liquid cash allows it to fund different opportunities and bridge gaps for its customers while other, guaranteed payments are made to the bank. So, where you might think your money is sitting happily in a bank vault, it is actually moving throughout the bank and helping to improve the entire banking system and its operations. Additionally, it’s making you and the bank lots of money!

On your end, a money market account works just like a checking account. Since people usually save money in a money market account for higher yields on their liquid cash, new debit cards or check writing services are offered to customers by the banks that manage the funds. Typically, the debit card or check writing service is limited to only a few withdrawals per month, so as not to turn the money market account into just another checking account.

Before opening a money market account (the process for opening such an account is just like opening a standard bank account), you should ask for several important details:

1. Is there a minimum balance? Because banks pay a higher rate of interest on money market accounts, they need for money to be in the account in order for them to use it to earn interest on the account. Also, minimum balances ensure that the bank isn’t opening accounts that are sure to lose the company money, since it costs the bank just as much to manage a $1 million money market account as it does a $5 money market account.

2. What is the APY? The APY is the yearly yield you can expect to earn on your savings. High APY means more money for your money! This is very important.

3. Are there any fees, and how do I access my money? These questions are often tied together because while there may be a fee for failing to keep a minimum balance, other fees are often assessed on accounts with too much withdrawal activity or those that require a greater level of service.

Because money market accounts are a virtual commodity, so don’t be afraid to shop around for an account that suits your needs perfectly. You may find that a higher-yielding account without all the bells and whistles fits your performance needs, while others may be willing to give up higher interest yields in exchange for a debit card or check writing service.