Is a Money Market Account Better Than a CD?
Money markets and certificates of deposits, or CDs, are both low-risk savings vehicles available from a wide variety of financial institutions. They are typically used for emergency funds and to "park" savings for a short time, when the investor does not want to take any meaningful risk with the money. CDs are usually issued by banks and savings and loan institutions and are then lent out in home mortgages, credit cards and commercial loans; money markets invest in short-term notes issued by governments and corporations.
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FDIC Protection of CDs
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From the consumer's point of view, the most important difference between money markets and CDs is that CDs generally come with insurance from the Federal Deposit Insurance Corporation (FDIC.) Currently, FDIC guarantees the principal of any CD, up to $250,000 in value.
Money Markets Lack FDIC Protection
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Money markets, while still extremely low-risk savings vehicles, do not come with FDIC protection. To compensate the investor, money markets frequently offer higher interest rates.
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Withdrawal Penalties
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When a bank issues a CD, it frequently plans to lend the proceeds in home mortgages and similar long-term debt. For that reason, it is important to the bank that you leave the money in the CD for the length of the contract. To discourage early withdrawals, a bank may impose a penalty, frequently six months' worth of interest, for early withdrawals.
Taxation
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Generally, money markets and CDs are taxed the same: Capital gains and losses are typically negligible, but both types of accounts generate interest. You will receive a 1099 form, and the interest is taxable.
Role in Your Portfolio
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Generally, the longer the term on the CD, the higher the interest rate. Many investors "ladder" CDs to take advantage of higher rates for longer CDs. As CDs come due, they will take the income they need, while the rest is invested in longer-term CDs at higher rates.
Money markets have no restrictions on early withdrawals, but many investors divide their money among several money market funds to mitigate the risk of a single fund losing money. It is rare -- money markets are managed to maintain a $1 per share price regardless of market conditions -- but it can happen.
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