Money Market Funds vs. High Yield Savings Accounts: 4 Key Differences
When it comes to earning a reasonable return on their savings, consumers may ask themselves: Should I choose a money market fund or a high-yield savings account?
The purpose is similar for everyone. They generally serve as a repository for short-term emergency funds or savings, such as buying a car, a home or a vacation, said Kamila Elliott, a certified financial planner and CEO of Atlanta-based Collective Wealth Partners.
That’s because money market funds and high-yield savings accounts are stable and allow for easy access, two essential features when saving money that you can’t afford to lose and that you might need in an emergency, said Elliott, a member of the CNBC Advisor Council.
“Both are very, very safe and provide liquidity,” said Greg McBride, chief financial analyst at Bankrate.
Plus, their returns are often higher than those of a traditional bank savings account. They have risen sharply over the past year and a half as the Federal Reserve has raised its key interest rate to curb inflation. Many are paying returns in excess of 4% and 5% after years of bottoming out.
In comparison, traditional savings accounts pay a paltry 0.54% on average (as of August 28). after at the bank rate.
And consumers don’t necessarily have to make an either/or decision.
“Many investors have both,” McBride said.
Here are some key differences.
1. Risk
High-yield savings accounts are bank accounts often offered by online institutions.
That means wearing them Federal Deposit Insurance Corporation (FDIC) insurance. This government-backed coverage insures bank deposits up to $250,000 per account.
Money market funds, on the other hand, are a little riskier – although they are also generally safe – experts said.
These are investment funds that are offered by brokers and asset managers. The funds typically hold safe, short-term securities, which, depending on the fund, can be, for example, U.S. Treasury bonds or high-quality corporate bonds.
The funds’ goal is to maintain a stable price of $1 per share. Money funds only have “ruined the money“A few times in history – perhaps most notably during the 2008 financial crisis, when the Reserve Primary Fund share price fell to 97 cents, triggered by the bankruptcy of Lehman Brothers.
According to a study from 2012, at least 21 other funds would have made a breakthrough between 2007 and 2011 without a capital injection from the fund sponsors report from the Federal Reserve Bank of Boston.
Because they are not bank accounts, money funds do not have FDIC insurance. They have Securities Investor Protection Corporation (SIPC) protection, which insures against loss of cash and securities up to $500,000 if an investor’s brokerage fails. However, SIPC does not protect against investment losses – it restores customers’ holdings during the liquidation process, but does not restore value if there has been a decline.
Investors who prefer money market funds might opt for government money market funds, which carry slightly less risk, Elliott said. These invest largely in US government bonds – i.e. government bonds – instead of in corporate bonds.
2. Yield
According to Elliott, money market funds tend to pay a slightly higher interest rate compared to high-yield savings accounts.
The highest-yielding money funds currently pay 5.4% to 5.5%, after to Crane Data. (This return is measured as the average 7-day annualized return of a fund. It is net of investment fees, which reduce the return.)
According to McBride, high-yield savings accounts currently pay up to 5.25%.
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While both tend to track the direction of the Federal Reserve’s interest rate, their yields rise for different reasons. The underlying investments in money market funds are directly influenced by the Fed, but banks tend to increase payouts to attract more customer deposits – which they then lend out to make money, experts say. Higher interest rates generally attract more deposits.
However, current interest rates are only a “snippet of time,” McBride said. From 2008 to 2021, high-yield accounts were “measurably higher than what funds were paying out,” he said.
It is unclear how long interest rates will remain this high. Some forecasters expect the Fed to begin cutting interest rates next year.
3. Minimum account
High-yield savings accounts generally don’t have minimum deposit requirements — and if they do, it’s a relatively small amount, McBride said.
Monetary funds typically require a minimum investment of more than $1,000, he said.
“It’s not necessarily a hurdle that everyone can overcome,” McBride said. Consumers should be wary if their balance falls below a certain value and a fee is incurred, he added.
4. Taxes
Interest income on both high-yield savings and cash funds would be taxed as regular income, experts said. At the federal level, these rates are up to 37%.
However, some money market funds may offer tax advantages, said Eric Bronnenkant, head of tax at Betterment. It’s important for consumers to consider their net return after taxes, he said.
Specifically, interest income from money funds that hold US government bonds could be exempt from state and local – although not federal – taxes, said Bronnenkant.
Generally, states allow investors to prorate the portion of income related to U.S. government debt, he said. For example, for a money fund that is 25% government bonds and 75% commercial debt, 25% of the investment would be exempt from state and local taxes.
(There are exceptions: California, Connecticut and New York require that at least half of the fund’s assets be invested in U.S. government bonds to qualify for a tax break, Bronnenkant said.)
Separately, asset managers also offer municipal money market funds, which invest in municipal securities that are exempt from taxes — but generally have a lower yield, McBride said.
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