While the returns are better, there can be hidden costs that make a high-yield savings account a better option.
Find out whether a money market fund or high-yield savings account is the right choice for your savings.
Case Study: Vanguard
Let’s start with a case study.
Vanguard is one of the largest brokerages in that U.S. and it is known for offering consumers access to low-cost investments.
One of the many investment options that Vanguard offers is the Prime Money Market Fund.
As of the time of writing (April 13th, 2018), the Prime Money Market Fund offers an SEC yield of 1.76% (and a compound yield of 1.77%).
The SEC yield is calculated using a formula developed by the Securities and Exchange Commission. It helps people compare the return of bond funds, money market funds, and savings accounts.
The SEC Yield is based on the return of an investment over the past 30 days.
The formula extrapolates the past 30 days’ returns to determine what your total return would be over the course of a year, assuming the return stays the same. The formula also takes expenses into account, so you don’t have to worry about the yield being lower after fees.
You can directly compare the SEC yield of a money market fund to the APY of a savings account.
Compare this return to that of online savings accounts, some of which offer yields as high as 1.70% APY.
Clearly, the Prime Money Market Fund offers a slightly better return.
Assume you invested $10,000 into the Prime Money Market fund today, and left it there for 10 years.
If the yield stayed the same on the money market fund, you’d have $11,906.14 at the end of the decade.
If you’d placed the money in online savings account yielding 1.70% each year, you’d have $11,836.12. After 10 years the difference in your total balance would be less than $100.
While it is true that money market funds offer a better return, the actual difference is not very big.
The difference is only really relevant if you have a large sum to save.
Reasons to Not Rely on Money Market Funds
If you’re just looking to save money and build up a cash buffer, a money market fund might not be a good idea.
One reason that money market funds aren’t the best choice for savings is that they involve risk.
When you invest money in a money market fund, the company that manages that fund then invests that money for you.
Generally, money market funds invest in high-quality, low-risk, short-term assets. These investments include short-term government bonds.
In the vast majority of cases, you will not lose any money in a money market fund because the assets involved are very low-risk.
However, there are some cases where money market funds can lose value. If this happens, you won’t have any way to recover the lost funds.
This is very rare as most companies will do everything in their power to prevent their money market funds from losing value.
Allowing that to happen can deal an almost insurmountable blow to a company’s reputation.
Loss of value is rare but possible
Brokerage accounts often advertise that they are insured by the SIPC. You may wonder how you can lose money if your account is insured, but SIPC insurance differs from the better-known FDIC insurance.
The Securities Investor Protection Corporation (SIPC) provides some insurance to investors.
However, this insurance does not protect the value of your investments.
Instead, the insurance protects investors against the failure of the brokerage holding your assets.
When you buy an investment through a brokerage, the brokerage holds the investment on your behalf.
In the unlikely event that the brokerage goes bankrupt, you might have trouble taking possession of your investment.
You might also have trouble transferring the investment to another brokerage.
SIPC insurance protects you in the event that a brokerage goes bankrupt. It will reimburse you for the value of investments lost because of a brokerage failure.
Another reason that money market funds might not be the right choice is their minimum investment requirements.
Some brokerages require that you have a minimum balance to open an account.
These minimums can be a thousand dollars or more.
If you’re trying to build up your savings, you might not have enough money to meet the minimum.
Finally, many brokerage accounts charge maintenance fees, just for having the account open.
These fees can quickly eat into any return you earn from your money market fund.
Most brokerages have a way to waive these fees. For example, you can sign up for electronic statements rather than paper statements in the mail.
Maintaining a minimum balance might also let you waive these fees.
If you can waive the fees, you don’t have to worry about them, but if you are charged fees, you likely would have been better off with a savings account.
High-Yield Savings Accounts Have Key Benefits
There are many benefits to keeping your savings in a high-yield savings account.
Easy, quick access
One benefit of keeping money in a savings account is that you can access your money easily.
If you keep your money at a brokerage it can take days to move the money to a bank where you can withdraw it.
If you keep your money in a savings account, you can withdraw it very easily.
Some savings account even offer ATM cards that let you withdraw money without visiting a bank.
When you need quick access to your savings, an account with an ATM card makes it easy to get the money you need.
No maintenance fees
Another benefit of savings accounts is the lack of fees. The vast majority of online savings accounts do not charge any fees. By contrast, the majority of brokerage accounts do have fees but offer a way to waive them. While you might be able to waive brokerage fees, it’s easier to not worry about fees at all.
Online savings accounts also tend to have very low minimum balance requirements. While brokerage accounts might require a minimum investment of $1,000 or more, you can start by depositing just a few dollars in a savings account.
Perhaps the greatest benefit of high-yield savings accounts is that they are extremely safe.
It is highly unlikely that you'll lose any money you’ve deposited into a savings account.
The Federal Deposit Insurance Corporation was founded in the wake of the Great Depression to help restore confidence in the banking system.
To that end, the FDIC insures the balances of deposit accounts up to $250,000, per person, per account ownership type.
That means you can have $250,000 under a personal account and $250,000 in a joint account, and have the full amount in both accounts be fully protected.
While money market funds can lose value, the FDIC guarantees that you'll never lose the money in a savings account (up to the covered limits).
If you absolutely cannot afford to lose any of your savings, you should use a savings account.
You Can Use Both
Something that is important to remember is that this isn’t an either/or choice.
You can open both a savings account and money market fund, and use them for different purposes.
Emergency fund first
You should definitely open a savings account to hold short-term savings.
Because you might need the cash in the near future, you want the easy access to your money offered by a savings account. You should also use your savings account to hold your emergency fund.
The goal of an emergency fund is to serve as a way to pay for unexpected expenses.
By their nature, you can’t predict when unexpected expenses might pop up, so you can’t afford to wait a few days for your shares in a money market fund to be sold and the balance made available to you.
You also can’t afford to have your emergency fund lose value, because you might find you don’t have enough to meet your financial need.
Keep roughly 3 to 6 months living expenses in your emergency fund.
Once you have some money you can afford to put at a slight risk, you can open a money market fund.
So long as you don’t need quick access to the money, you can deposit it to a money market fund.
This will give you the chance to earn a bit more interest while maintaining most of the safety of a savings account.
Exceeding FDIC limits
Another good time to use a money market fund is if you have a lot of money to invest.
Once you break the $250,000 FDIC insurance limit, there’s no reason not to take on the risk of a money market fund.
If you have that much money available to you, definitely consider opening a money market fund.
Savings accounts and money market funds act somewhat similarly but are actually quite different.
Savings accounts offer complete safety, which is ideal for money that you can’t afford to lose.
Money market funds offer a small increase in potential return but make it harder to access your cash and introduce some risk to the equation.