Money market accounts and CDs are known as low risk, low reward investment vehicles that are great for parking cash to be used in a short period of time or as a place to put money while deciding where to invest it. But which is better? Let’s take a close look at money market accounts and certificates of deposit and see how they compare.
Certificate of Deposit (CD) Overview
CDs are debt instruments issued by financial institutions such as banks and brokerages to individuals. When you invest in a CD you are basically agreeing to lend your money to the financial institution in return for a fixed amount of interest. CD rates vary and are typically low. CD maturity dates range from just a few weeks to several years. The longer you invest the higher the rate. Most CDs have early withdrawal penalties should you want or need to pull your money out before the term is complete.
Pros: CDs are very low risk. They are FDIC insured, which means if the bank goes belly up your funds are protected. As an investor you also know what the rate of return will be. CDs are great wealth preserves rather than wealth creators. They are great for retirees who want to protect their existing wealth. They are also a great place to park some cash that you will need in the near future for a down payment on a house or college tuition.
Cons: CD rates are often low. In fact, many of the rates in today’s economy do not even keep pace with inflation. Plus, you do not have access to your money until the CD matures. In the case of an emergency, you would have to use other funds or take a substantial penalty for withdrawing money from your CD early.
Money Markets Overview
Money market accounts offer many of the same benefits of certificates of deposit, but are very liquid. In other words, you can draw money from the account because of the check-writing privileges. A money market account is basically a type of low risk mutual fund where fund managers invest in government t-bills, savings bonds, CDs and other safe investments. The income earned is then paid out to the money market account holder.
Money market accounts are easy to open and available through most banks. You will typically receive a check book to use when you open the account.
Pros: Opening an account is easy. Depositing your money in a money market account is as easy as putting money into your checking or savings account. The cash is then immediately available for you to use as you see fit.
Cons: The rate of return is typically low, just like CDs. You also have limited check writing privileges in most cases. Also, money markets typically yield a higher return for more wealthy investors who can invest more money.
Money market accounts are generally considered the superior option to preserve wealth and to park cash in between investments. The liquidity aspect favors the money markets because you have access to your cash when you need it. Also, the interest rates are very comparable so why not go with a money market account that keeps you in a liquid position rather than tying up your money.
When selecting a money market account make sure you check around for the best rates. It should also be noted that money market accounts are different than money market funds. Money market funds pay a higher rate of return but are not insured by the FDIC where as money market accounts are.