Is Money Market Income Dividend or Interest Income?
Money market income can be either dividend or interest income depending on how you invest in money market instruments. In the end, what matters is how much income you get from money market investments. Knowing whether it's dividend or interest income only helps you understand the structure of an investment and the associated risks, if any.
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Money Market Instruments
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The money market is a market for short-term, high quality debt instruments issued by governments and corporations, such as Treasury bills, commercial paper and repurchase agreements. As debt instruments, they pay interest. An investor who holds a money market instrument receives interest income.
Money Market Funds
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Most money market instruments are issued and traded in large denominations so for the most part only institutions can afford to buy them direct. Retail investors can invest in those instruments through money market funds. A money market fund is a mutual fund that issues shares to investors and buys money market instruments with the proceeds. It receives interest income which it passes on to the fund investors in the form of money market fund dividends. In effect, money market fund investors receive interest income in the form of fund dividends.
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Tax-Free Income
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There is no such thing as tax-free dividends. All dividends are taxable -- with one exception. Money market funds that invest in short-term, tax-free municipal debt pass that tax-free interest income on to the investors in the form of dividends that are not taxed because the underlying income is not taxed, in effect paying tax-free dividends.
Money Market Accounts
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Many banks offer money market accounts that pay higher interest rates than savings accounts. Any bank product is, by definition, a fixed-income product, so bank money market accounts pay interest income.
Money Market Accounts Vs. Money Market Funds
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Rates on money market accounts and money market funds may be similar. The main difference is that money market accounts are bank products that are federally insured, whereas money market funds are investment products offered by mutual fund companies and are not insured. Retail investors have never lost money in a money market fund, but there is no guarantee.
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