Money Markets Vs. Savings Accounts

Both money-market accounts and savings accounts serve the same purpose---to protect investors' principal and generate a modest income. However, the accounts do not operate in the same way. For most investors, money-market accounts represent a better investment.

What is a money market

Money markets come in two flavors.
Money-market accounts look a lot like savings accounts. Investors obtain such accounts at banks or similar institutions, and the accounts are guaranteed up to a certain amount by the Federal Deposit Insurance Corporation (FDIC). Some money-market accounts offer check-writing privileges.
Money-market funds are mutual funds that invest in cash and securities considered equivalent to cash. Such funds tend to purchase securities like certificates of deposit, U.S. Treasury bills, and commercial paper (credit used by businesses to cover short-term operating liabilities). Mutual-fund companies sponsor these funds, which do not qualify for FDIC guarantees. However, the Securities and Exchange Commission ensures the safety of these funds by limiting the investment choices to safe, short-term investments. Many money-market funds allow check-writing privileges.

What is a savings account

The traditional passbook savings account has changed little in the last 50 years. Investors generally open them through banks. The money sits safe and sound at the bank, generating a small amount of interest. Savings-account holders enjoy minimal transaction privileges, generally limited to depositing and withdrawing cash. The FDIC guarantees savings accounts.

Investment returns

Savings accounts generally pay lower interest than money-market accounts. Money-market accounts in turn generally pay lower interest than money-market funds. None of the three options offers long-term returns that approach those of stocks or most types of bonds. The greater risk an investor assumes, the greater return potential he can expect. However, among cash and cash-equivalent investments, the money-market fund typically packs the biggest punch.

Tax advantages

Interest from savings accounts and money-market accounts is usually taxable. Investors wishing to protect themselves against taxes can find some options in money-market funds. Some funds that buy different types of government bonds pay dividends immune from state taxes, federal taxes, or both.

Investment appeal

Savings accounts and money markets share three characteristics that appeal to many investors:
---Safety. The value of these accounts does not fluctuate. Savings accounts must be considered a bit safer than money markets.
---Liquidity. Investors can easily move money in and out of savings accounts and money markets. Because their value does not fluctuate, investors need not time buys and sells to maximize profits. Savings accounts and money markets are equally liquid.
---Steady income. Most money markets and savings accounts pay interest or dividends monthly.