Saving and investing are definitely two distinct activities but that doesn’t mean you shouldn’t look for ways to maximize your savings plans. You don’t always have to open a traditional savings account for the security and liquidity you need for your emergency fund or for short term savings goals.
Savings accounts aren’t always what you think
In addition to savings accounts, there are at least three other major places to park your cash: CDs, money market funds, and money market deposit accounts.
Certificates of deposit (CDs) are bank-issued savings certificates that pay a certain fixed yield over a set period of time, called a term. CDs can be issued in any amount and are FDIC-insured for up to $250,000. In general, the longer the term, the higher the CD’s yield. For example, if you put $1,000 of your savings into a five-year CD with a 5% yield, you’ll receive 5% of your balance in interest each year for five years, guaranteed. CDs do have one major drawback—you can’t withdraw from the CD during the term without incurring a substantial penalty (usually about 10% of the withdrawal amount).
- Security: High, usually FDIC insured.
- Liquidity: Variable, but you can withdraw your money with a penalty. You can also set up 30 day CD’s if you think you’ll need money in a hurry.
Money Market Deposit Accounts
Money market deposit accounts are a more restrictive type of savings account. Generally they allow few withdrawals and require a high minimum balance in order to avoid fees. In exchange, they tend to offer slightly higher yields than money market funds, CDs, or traditional savings accounts. They’re also FDIC-insured up to $100,000 per account.
- Security: High, money market deposit accounts are usually FDIC insured.
- Liquidity: Variable, but you can withdraw your money with relative ease. These are not considered “transaction accounts,” so the bank or financial institution may limit the number of withdrawals you can take each month before incurring a penalty (usually three).
Money Market Funds
Money market funds are a type of mutual fund offered by investment companies and some banks. Money market funds have yields that tend to be somewhat higher than those of savings accounts, but they are not FDIC-insured. Nonetheless, it’s highly unlikely that you’d ever lose money in a money market fund. If you do use money market funds, it’s best to do so at a well-established national bank or investment company. These funds do not invest in stocks but in short-term debt instruments purchased on what’s known as the “money market.”
The “money market” is not a particular place, but rather how the US government, banks, corporations, and other large institutions manage their short-term cash needs (yes, through borrowing).
- Security: High. Though NOT insured by the FDIC, money market investments generally have a high credit quality, which means that there is little risk that their issuers will not be able to repay their debt. Because of this high quality, they are considered low-risk investments..
- Liquidity: Medium high, only because it may take a few days to get your cash should you need it. Money markets do not require you to invest your money for set amounts of time like a CD. You can typically withdraw your money whenever you need it, without paying a penalty.
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Note: This article was included in the 241st Carnival of Personal Finance at My Journey to Millions. Check it out!