About the Money Market

The money market refers to the financial market made up of financial assets with maturities of less than one year. Generally speaking, the money market includes short-term Treasury securities, short-term municipal bonds, commercial paper, and large-denomination short-term negotiable certificates of deposit, but not certain commodity futures or financial derivatives with maturities under one year. Its main role is to provide short-term financing and working capital for businesses, interbank lending, and trading in various short-term securities. Money market instruments are typically highly liquid, have short maturities, and carry relatively low default risk. (Source: wiki)

For individual investors, there are two main ways to use the money market.

  • Money Market Account (MMA): a bank deposit account similar to a savings account
  • Money Market Fund (MMF): a fund that primarily invests in the money market

Both options are relatively low risk and generally offer stable returns. Below, we’ll briefly go over each one.

Money Market Account

Overview

  • Yield: 0.1%-3% (varies with the market, not locked in)
  • Risk: Basically none (FDIC insurance up to $250,000)
  • Flexibility: Medium
  • Payout frequency: Once per month
  • Fees: None (usually can be waived)
  • Taxes: Interest income tax

A Money Market Account is an interest-bearing deposit account offered by a bank. Some banks may require advance notice for withdrawals, while others do not. It is a type of U.S. deposit account subject to federal savings account regulations, such as limits on certain monthly transactions. MMAs are also covered by FDIC insurance, with the same $250,000 limit.

You can think of an MMA as a type of savings account, since depositing money, opening the account, and FDIC protection are all very similar. The difference is that MMAs usually come with more restrictions than a typical savings account, such as minimum balance requirements, monthly fees, limits on monthly withdrawals, and transfer limits. As mentioned earlier, banks may use MMA deposits to invest in the money market, so the interest rate is often a bit higher than on a standard savings account. In a sense, you trade some flexibility for a higher rate.

Opening an MMA is also similar to opening a savings account: you can usually do it online with the bank or in person at a branch.

Rates and requirements

Just like with savings accounts, big banks often do not offer the most competitive MMAs, while smaller banks may have better options. Since they are still FDIC-insured and most people do not use them very frequently, using a smaller bank is usually fine. Below are a few solid MMA options (data as of August 25, 2022). If you want to open one, be sure to read the rate requirements and the bank’s own account requirements carefully.

Here we’ll use CFG Bank’s MMA as an example. A 2.55% APY is pretty attractive. Different banks have different requirements, so make sure to review them carefully before opening an account.

  • Minimum balance: You need a Daily Balance above $1,000 to earn this APY
  • No more than 6 outgoing transactions per month: including automatic transfers, phone transfers, online transfers, bill payments, checks, debit card purchases, etc.
The deposit agreement may impose limits on the number of certain types of withdrawals and transfers you can make each month from your Money Market account. You may make no more than a total of six (6) automatic or preauthorized transfers, telephone transfers, Online Banking transfers, or payments from your account each month, including payments by checks, drafts, and debit cards to third parties. You can, however, make unlimited withdrawals in person at the bank, at an ATM or by mail. Violations of these transaction limits may subject the account to closure. See fee schedule for excessive transaction fee and other fees that may apply to your account.
  • Transfer-out limit of $5,000 per day and $30,000 per rolling 30 days
Once funding occurs the daily external transfer limit for the CFG High Yield Money Market Account is $5,000. Your external transfers may not exceed $30,000 in a 30-day rolling period.
  • $2 monthly fee: waived if the account balance is over $100

Overall, the restrictions are not too burdensome. If you do not need the money urgently within a month, this account should offer enough flexibility for most needs.

Taxes

Like a savings account, the interest earned from an MMA is taxable and is effectively added directly to your total income. Depending on your income, the tax rate can range from 10% to 37%. For each tax year, you only need to consider the total interest paid during that filing year. Note that nonresidents (for example, students who have been in the U.S. for less than 5 years) generally do not pay tax on bank interest.

Money Market Fund

Overview

  • Yield: 0.1%-3%
  • Risk: Low
  • Flexibility: High
  • Payout frequency: Once per month
  • Fees: Management fee (usually already reflected in the yield)
  • Taxes: Depends on the type of fund

A money market fund (MMF) is a mutual fund that invests in short-term money market securities, generally with maturities of less than one year and an average maturity of 120 days. Fund assets mainly invest in short-term instruments such as Treasury bills, commercial paper, bank CDs, bankers’ acceptances, short-term government bonds, and corporate bonds.

In theory, an MMF is simply a type of fund whose investments are limited to the money market, so the risk is relatively low and the cash remains fairly flexible.

Yields

MMFs are popular with brokerages and investment platforms. Many brokerages even automatically sweep uninvested cash in your account into an MMF so users can earn some yield on idle cash. Several platforms offer MMFs with fairly attractive yields.

For example, Vanguard places temporarily uninvested cash into VMFXX (Vanguard Federal Money Market Fund).

Fidelity uses SPAXX by default, with a 7-day yield of 1.77%

Fidelity also offers SPRXX, with a 7-day yield of 2.09%

Schwab does not automatically invest your cash into an MMF, but you can buy its SWVXX, which has a 7-day yield of 2.16%

Trading MMFs and holding costs

One advantage of MMFs is that buying and selling usually does not come with extra trading commissions, so you can sell when you need cash and buy when you temporarily do not want to invest elsewhere. Take Schwab’s SWVXX as an example.

That said, trades generally need to be completed on business days, so MMFs are still a bit less flexible than a normal savings account. There is no separate holding fee for MMFs, because the management fee is already built into the quoted yield and deducted automatically.

Risk

As a type of fund, MMFs are not protected by the FDIC, so there is some risk involved. The risk depends on the stability of the money market instruments the fund invests in. In general, MMFs invest in short-term financial products, so the risk is relatively small.

Taxes

The tax treatment of an MMF depends on the underlying investments. If the fund invests in taxable products such as government bonds, then the income is taxable. If it invests in non-taxable instruments, such as Municipal money funds, then the income may be tax-exempt. Investment platforms also typically list both kinds of products for users to choose from. For example, on Schwab:

  • Tax-exempt MMFs
  • Taxable MMFs

For taxes, taxable MMFs are generally reported like interest income, meaning the earnings are added directly to your total income. Depending on your income, the tax rate can range from 10% to 37%. Note that nonresidents (for example, students who have been in the U.S. for less than 5 years) generally do not pay tax on interest income.

So how do you choose between taxable and tax-exempt funds? You can estimate your overall income and tax bracket, then calculate which one gives you the better after-tax return. For example, if you are in the 20% tax bracket, you can multiply the taxable MMF’s yield by 80% and compare that result with the yield on a tax-exempt MMF.

Summary

Money market investing offers a strong balance of yield and flexibility. An MMA is similar to a savings account and is better suited for money you do not need right away but may need in the short to medium term. MMFs are more flexible from an investing standpoint, since you can buy them whenever you want, but because they do not have FDIC protection, it is still a good idea to review historical yields and use a large, reputable platform.

For other low-risk cash management and investing options, see: