Too Little Return versus Too Much Risk – Choosing the Right Money Market Account

So where is the best place for your money to stay safe? The whole idea with managing money that you might need is to keep it liquid. You always want the ability to get to the money. There is a going rate for that type of risk-free account, which is why it is good to know your options.

Let’s start with the lowest risk and lowest-paying account – the savings account.

We have always been taught to just open a savings account. Unfortunately, savings accounts pay virtually nothing in interest. I checked the going rate at one of the major U.S. banks. They are currently paying 0.20%. They are also using this low-paying account as the main savings account for one of their heavily marketed savings programs.

The second type of account would be a money market account.

Theoretically with a money market account, you position yourself to get a little higher return. Most money market accounts are FDIC-insured. They are considered deposit accounts in banks.

What is the big difference between a money market account and a savings account? The main difference is that a money market account will typically limit the number of withdrawals you can make, while a savings account has unlimited withdrawals.

The rate goes up a little in a money market account. At Bank of America, they will pay 1.75% up to $25,000 and then increases to 2.8% up to $50,000.

The third type of account would be a money market fund.

This is actually a mutual fund that invests in money market type instruments. It is considered a safe investment although you could lose money. Every dollar you place in the money market mutual fund represents one share that is worth $1. The accounts are arranged so that the $1 per share value never goes down.

So, what is a good rate for a money market mutual fund? At this time, Fidelity is paying 4.75%.

Could you lose money in a money market mutual fund? Well in a traditional money market mutual fund, the probability is much lower. It would have to be some type of dramatic situation. I have never heard of a traditional money market mutual fund losing money. However, I am not implying that it cannot happen.

If you are in the fourth category, you could lose money. The fourth category consists of enhanced or strategic money market mutual funds.

These take a little more risk to get a higher return. Unfortunately, it has been discovered that these funds have invested in these mortgage-backed securities and many are in trouble.

Just this morning, Bank of America announced they were closing their 12 billion dollar enhanced money market fund because of problems.

Where is the best place to look? This is not intended as advice. I think that the risk taken with a money market mutual fund makes the most sense. There is a big enough difference in return. However, there is one word of caution.

Make sure you are only using a traditional money market mutual fund and not one of the enhanced funds that are in that fourth category. It just isn’t worth the risk.

Copyright © 2007 Prudent Money and Bob Brooks. All rights reserved.