Money market deposit accounts and mutual funds are a safe place to park your cash for a short period of time. But before you put a chunk of money into either one, make sure you understand:
Money market deposit accounts are a cross between a checking and a savings account. They earn a bit more than interest-bearing checking accounts, but restrict the number of deposits or withdrawals that can be made each month.
These deposit accounts are offered by banks and are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per person, per bank. As long as the balance in the account remains below the insurance limit, every bit of principal and interest earned on the account is 100% guaranteed. (To learn more about how your money is protected by the FDIC, read Nolo's article FDIC Insurance: How Safe Is Your Money?)
Like most safe investments, they won't make you rich. The rate of return paid on the accounts varies according to market conditions and the bank's standard rates, but in today's market, is usually only a tad higher than standard savings account rates. By and large, they generally pay a bit less than the rate of inflation.
Money market mutual funds are offered by investment companies. They are investment pools that buy safe, short-term securities, such as Treasury bills, certificates of deposit, and commercial paper. (Commercial paper is an IOU issued by a company that needs money in the short term to finance accounts receivable, inventories, or other short-term needs.) Unlike money market deposit accounts, but like other investment accounts, money market mutual funds are not federally insured.
The income earned on money market mutual funds will vary based on the performance of the underlying investments. But, because these investments are fairly safe, they don't pay high returns -- although the yields are a bit higher than on money market deposit accounts.
Beware of money market funds offering a high return. If a money market fund's return is a lot higher than that of a deposit account, take a closer look. A high return on one of these funds could mean the investment manager is doing something fishy, making the fund less safe than average.
Both money market deposit accounts and money market mutual funds are simply places to keep your money for the short term. They are not good places to put your money for long-term investment. Because they earn so little, parking long-term assets in a money market guarantees you'll lose buying power to inflation.
To decide which type of money market is best for you, consider your reasons for setting this money aside.
To learn about more about investing and other money issues affecting families, get The Busy Family's Guide to Money , by Sandra Block, Kathy Chu, and John Waggoner (Nolo).