5 Money Market Account Misconceptions

Money market accounts can keep your money safe and liquid. But they do have downsides to consider and they are often misunderstood and misused. But what are they? And how do you avoid some of the mistakes most people make when they invest in these low-interest-bearing vehicles?

Learn about the five biggest mistakes investors make with money market accounts. 

What Are Money Market Accounts?

Money market accounts are deposit accounts held at banks and credit unions. Often referred to as money market deposit accounts (MMDA), they often come with features that make them distinct from other savings accounts. They are considered a great place to hold your money temporarily, especially when the market is raging with volatility and you can't be sure of any other safe haven.

When you hold a money market account, you can be certain your balance is insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000.

Many money market accounts come with check-writing ability and a debit card. Some banks limit the amount of transactions that can be done in an account, however. Before April 2020, the Fed limited this to six, but this limit was removed to help individuals during the Coronavirus pandemic. Banks are still allowed to impose their own limits.

These accounts are interest-bearing—generally single-digit returns—and may pay a little more than a traditional savings account. That's because they can invest in low-risk, stable funds like Treasury bonds (T-bonds) and typically pay higher rates of interest than a savings account. While the returns may not be not much, money market accounts are a good choice to consider during times of uncertainty.

Misconception #1: They Are Money Market Funds

Mistaking a money market account for a money market fund is common, but there are critical distinctions between the two financial instruments. 

A money market fund is a mutual fund characterized by low-risk, low-return investments. These funds invest in very liquid assets such as cash and cash equivalent securities. They generally also invest in high credit rating debt-based securities that mature in the short term. Getting in and out of an MM fund is relatively easy, as there are no loads associated with the positions. 

Often, though, investors will hear "money market" and assume their money is perfectly secure. But this does not hold true with money market funds. These types of accounts are still an investment product, and as such have no FDIC guarantee.

Money market fund returns depend on market interest rates. They may be classified into different types such as prime money funds which invest in floating-rate debt and commercial paper of non-Treasury assets, or Treasury funds which invest in standard U.S. Treasury-issued debt like bills, bonds, and notes.

Misconception #2: They Are a Safeguard Against Inflation

A common misconception is believing that placing money in a money market account safeguards you against inflation. But that's not necessarily true. Money market accounts are not designed to outpace inflation. Rather, it is simply to grow savings at a faster rate than traditional checking or savings accounts.

Let’s assume, for example, that inflation is lower than the 20-year historical average. Even in this situation, the interest rates banks pay on these accounts decrease as well, affecting the original intent of the account. So while money market accounts are safe investments, they really don't safeguard you from inflation.

Misconception #3: A Large Allocation Is Efficient

The changing rates of inflation can influence the efficacy of money market accounts. In short, having a high percentage of your capital in these accounts is inefficient.

Six to 12 months of living expenses are typically recommended for the amount of money that should be kept in cash in these types of accounts as emergency funds. Beyond that, not investing will mean missing potential earnings.

Misconception #4: They Are the Best Option

In many instances, we are programmed to believe that saving money is ideal. But investing it well can get you greater returns. Staying in a cash position for too long instead of investing can result in the loss of potential gains. High-yield returns on your money generally require diverse investments.

Misconception #5: One Account Is Enough

Diversification is one of the fundamental laws of investing. Cash is no different. If you insist on holding all your money in money market accounts, no one account should hold more than the FDIC-insured amount of $250,000. It is not uncommon to see families or estates with multiple bank accounts insuring their money as much as possible.

Using this strategy, dividing the money up into three “buckets” can prove useful. Having money set aside for the short-term (one to three years), the mid-term (four to 10 years, and the long-term (10 years plus) can lead investors down a more logical approach to how long—and how much—money has to be saved. To take a more tactical approach, we can apply the same buckets and assess your tolerance for risk in a realistic way. 

Consider putting long-term money into other low-risk investment vehicles like an annuity, life insurance policy, bonds, or Treasury bonds. There are countless options to divide your net worth to hedge the risk of losing the value of your money kept in cash.

These approaches can help to outpace current and future inflation while protecting money from losing its value. Understanding how different investment types works, including the risks and potential rewards, will allow you to make the right decision for your situation.

Frequently Asked Questions (FAQs)

The Bottom Line

Money market accounts serve a singular purpose: To keep your money safe. Ultimately, you'll want to research all your options and perhaps consult with a financial advisor to determine how the best way to use your cash to meet your financial goals.