Understand the difference between money market funds and money market bank accounts. Because you can lose money with money market funds.
One of the more interesting choices for saving up for an emergency is the money market fund. With it's slightly higher gains than what you can get from a more traditional savings account, and the ability to withdraw money as needed, money market funds have been popular cash management tools.
I recently received a question from a reader about these investments:
I am looking for a safe place to put my cash, and earn a decent yield. Money market funds look like a great choice. I just want to make sure that my money is safe and FDIC insured. Because it's money market, is my money completely safe with these funds?
The short answer, dear reader, is “no.” I think you might be mixing up money market funds with money market accounts. This is a common mistake.
Money Market Mutual Funds vs. Money Market Bank Accounts
Both of these financial vehicles use the name “money market” because they are in some way related to cash rates and the money markets. However, they are two completely different products, and you need to understand that — especially before you invest in a money market fund.
A money market fund is actually a mutual fund. It's an investment based on cash investments, and other certain investments that are sometimes considered “like cash” or similar to cash. Money market funds are generally considered relatively safe, but, because they are investments, there is the potential for loss. In fact, in 2008, with the bankruptcy of Lehman Brothers and the crash in the markets, there were losses in money market funds.
While the government helped guarantee some of the money market funds during the financial crisis in order to prevent a complete run on them, and make things even worse, it's important to note that money market funds are not normally guaranteed. And they certainly are not FDIC insured.?If you invest in a money market fund, you run the risk of loss. Plain and simple.
Contrast this with a money market account. A money market account is a product offered by many banks and credit unions. Even when you have money market account that allows you to write checks, these accounts are usually classified as savings accounts. In some cases, depending on market conditions, you can receive a higher yield from a money market savings account than a “regular” savings account. However, chances are that you will also need to maintain a higher minimum.
A money market account is FDIC insured. If you are interested in making sure that your money is safe from bank failure, you need to double-check that you are using a money market account; don't use a money market fund if you want protection from losses.
Knowing the difference between a money market fund and a money market account matters, especially if you are trying to protect yourself against loss. Study the differences between the two, and choose the option that works best in your situation.