- Consumers looking to earn high interest rates on their savings while having easy access to cash often find themselves torn between high-yield savings accounts and money market funds.
- “Both are very safe and offer liquidity,” said Greg McBride, chief financial analyst at Bankrate.
- However, there are important differences in terms of risk, tax, yield, etc.
When it comes to getting a good return on their savings, consumers may ask, “Should I choose a money market fund or a high-yield savings account?”
The purpose of each is similar. According to Camilla Elliott, a certified financial planner and CEO of Atlanta-based Collective Wealth Partners, these are typically an emergency fund or perhaps a savings account for short-term purposes such as buying a car, home or vacation. It functions as a storehouse.
That’s because money market funds and high-yield savings accounts are stable and easily accessible, CNBC Advisor Council member Elliott said. .
“Both are very safe and offer liquidity,” said Greg McBride, chief financial analyst at Bankrate.
Moreover, their yields are often higher than traditional bank savings accounts. Interest rates have risen sharply over the past year and a half as the US Federal Reserve (Fed) raised benchmark interest rates to curb inflation. Many companies that have sat near rock bottom for years are paying yields above 4% or 5%.
By contrast, as of August 28, traditional savings accounts are paying just a meager 0.54% on average. according to to bank credit.
Also, consumers don’t necessarily have to choose between the two.
“Many investors have both,” McBride said.
Here are some of the key differences.
A high yield savings account is a bank account, often offered by an online institution.
This means that you are insured by the Federal Deposit Insurance Corporation (FDIC). This government-backed coverage guarantees bank deposits of up to $250,000 per account.
Money market funds, on the other hand, are generally safer but slightly more risky, experts say.
These are mutual fund investments offered by brokers and asset managers. The Funds generally hold safe short-term securities, which in some Funds may be, for example, US Treasuries or high-quality corporate bonds.
The fund seeks to maintain a stable price of $1 per share. The money fund only has “”.broke the money“There have been several times in history, perhaps most notably during the 2008 financial crisis, when the Reserve Primary Fund stock price fell to 97 cents in the wake of the collapse of Lehman Brothers.
At least 21 other funds would have paid off between 2007 and 2011 without capital injections from fund sponsors, according to a 2012 report. report By the Federal Reserve Bank of Boston.
Money Funds are not bank accounts and are not covered by FDIC insurance. They are protected by the Securities Investor Protection Corporation (SIPC), which insures up to $500,000 in cash and securities losses in the event of investor brokerage failure. However, SIPC does not protect against investment loss. The client’s holdings will be restored during the liquidation process, but not if they have fallen in value.
Investors who prefer money market funds may opt for sovereign money market funds, which offer slightly less risk, Mr. Elliott said. They primarily invest in US government bonds, or Treasuries, rather than corporate bonds.
Money market funds tend to pay slightly higher interest rates than high-yielding savings accounts, Elliott said.
The highest yielding money fund currently pays 5.4% to 5.5%. according to to crane data. (This yield is measured as the fund’s average annualized 7-day return. Investment fees that lower the yield are subtracted.)
High-yield savings accounts currently charge up to 5.25%, McBride said.
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Each tends to track movements in the Federal Reserve’s base rate, but each yields higher for different reasons. Fundamental investments in money market funds have been directly impacted by the Fed, but banks tend to increase dividends to attract more customer deposits, experts say. It is said that they are making money by renting out. In general, higher interest rates attract more deposits.
But current rates are only “part of the time,” McBride said. From 2008 to 2021, high-yield accounts “clearly exceeded what the fund paid,” he said.
It is unclear how long interest rates will remain at this high level. Some forecasters believe the Fed will start cutting rates next year.
High-yield savings accounts typically don’t have minimum deposit requirements, and when they do, they’re relatively small, McBride said.
Money funds often have a minimum investment of more than $1,000, he said.
“It’s not necessarily a hurdle that everyone can clear,” McBride said. Consumers should be aware that there will be fees if their balance falls below a certain level, he added.
Both high-yield savings and money fund interest income are taxed as regular income, experts say. This rate reaches up to 37% at the federal level.
But Eric Bronekant, head of tax at Betterment, said some money market funds may have tax incentives. He said it is important for consumers to consider the net after-tax yield.
Specifically, interest income from money funds that hold U.S. Treasuries, while not federal taxes, could be exempt from state and local taxes, Bronnenkant said.
Generally, states allow investors to prorate the portion of their income related to U.S. government debt, he said. For example, for a money fund holding 25% government bonds and 75% commercial debt, his 25% of investments are exempt from state and local taxes.
(There are exceptions. In California, Connecticut and New York, at least half of the fund’s assets must be invested in Treasuries to qualify for the tax cuts, Bronnekant said.)
Separately, the asset manager also offers municipal money market funds. The fund invests in tax-exempt municipal securities, which generally offer lower yields, McBride said.
