Exploring the difference between Savings Accounts, CDs, and Money Market Accounts
Chances are you’ve heard of savings, CD, and money market accounts, but you may not be familiar with the advantages and disadvantages of each. While there definite differences between the three types of accounts, the have several characteristics in common as well including the following:
- FDIC Insured: These accounts are insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 each (at the time of this writing). This means that if the bank goes out of business while holding your funds for any reason, you will be reimbursed for the full amount (including principal and interest earned) without losing any money.
- Low-risk investment: As far as investments go, all three accounts are pretty much the lowest risk you can get. Interest rates are clearly defined and, barring any bank penalty fees, you cannot lose principal. This makes these investments ideal for cash holdings and emergency funds since they are extremely safe and highly liquid.
- High Liquidity: An investment has high liquidity if it can be withdrawn easily in cash. These three options represent some of the most liquid investments available anywhere. Typically you can receive your cash within 1-7 business days.
Just about every brick-and-mortar bank offers these products and online banks are increasing in popularity as well. If you have some cash savings that you wish to invest with the minimum amount of risk, these are the most viable options out there.
The Emergency Fund
An emergency fund is basically a cash reserve that can support you financially during… well… emergencies. It is recommended by nearly every financial planner to have an emergency fund however the actual amount of this fund can vary depending on who you talk to. Generally it is recommended to have six months of income in reserve to handle situations such as illness, job loss, unforeseen large expenses (home/car repair), etc. Six months of income is a lot of cash to have not working for you which is essentially how these products came to be.
Most people currently have or at least know someone that has a savings account. These are the most popular and easiest accounts to setup and are offered by virtually every bank. Savings accounts are simply accounts where the bank pays a small amount of interest for you to maintain. The bank makes money by lending these funds out in the form of loans to other bank members and they pass some of these profits onto the savings account owner; you.
Savings accounts are the most liquid interest bearing account you can get meaning you can move money in and out with little or no delay. Some banks have hidden fees as well such as minimum balance and maximum transaction limits. Make sure you understand the fees associated with your savings account, one bank fee can negate several months of savings interest.
Money Market Account
A Money Market Account (MMA), or money market direct deposit account, is essentially the same thing as a savings account from the customer’s perspective. The difference is in the types of investments the bank can make with these funds. With savings accounts, banks are restricted to loans made to individuals who need to borrow money at a set interest rate. These loans are much safer but aren’t as profitable for the bank. With a money-market account, the restrictions get a little looser. The bank may invest in products outside of the bank itself such as bonds, treasury notes, and even CDs. Because these investments offer a higher rate of return, these profits are once again shared with the account holder.