MONEY MARKET ACCOUNTS

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MONEY MARKET ACCOUNTS

Published by sam - 29/08/07 - 03:08:52 am

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The money market accounts offered by banks can be confusing for three reasons. First, the same basic account is given a wide variety of names by different banks. Money Management Account, Market Plus Account, Investor’s Choice Account, and so forth. Second, the money market account is easily confused with the Super NOW accounts, an interest-paying checking account. Third, the money market account is also easily confused with the money market mutual fund, which is similar in some respects but is not offered by banks. Regardless of its name, however, the money market account available from banks has the following characteristics.

Like a regular savings account, a money market account typically earns interest at 5.25 percent up to a specified balance—usually $1,000 to $2,500. Beyond that level, the interest rate rises to what banks call the “market interest rate”—a rate that fluctuates but normally is about one percentage point higher than the rate paid on Super NOW.

Like a savings account, the money market account is federally insured, and there is no limit to the size or the number of deposits or withdrawals that you can make. But while you are entitled to write three checks per month on the account, exceeding this limit can cost you a penalty of $5 to $10 per check. And, because its interest rate is higher than that of a regular savings account, some people use the money market account as a temporary parking place for funds awaiting other kinds of investments. Keeping such funds in a regular savings account or Super NOW account would earn them less, and depositing them in a non interest paying checking account would earn them nothing.

Unlike the fixed rate earned by a savings account, interest rates on a money market account may fluctuate from week to week, reflecting changes in the market interest rate. But, although the rate is basically determined by the market interest rate, there is no legal restrictions on what banks can pay. Consequently, the rates paid by individual banks are likely to vary slightly, depending on a bank’s need to attract new deposits and retain existing ones and on the region in which a bank is located. Although such rate variations are unlikely to amount to more than one-half of a percentage point, there is no reason why you cannot open a money market account anywhere in the country you can find a better rate. But you will have to be willing to make deposits by mail, make withdrawals for a fee via an ATM network, limit checks to three per month, and forgo the convenience of a local branch.

Interest Computation
As important as the interest rate paid by a particular bank is the balance on which the bank computes the interest. Banks use one of two methods:

A bank that uses the tiered method pays the same rate of interest on your entire balance, the actual rate being determined by the size of that balance. Thus, a balance of less than $1,000 might earn 5.25 percent, but once you increased your balance to, say, $8,000, the entire $8,000 would earn the higher “market” rate.

Some banks, however, use the blended method to compute interest. Under this method, your first $1,000 might earn only $5.25 percent no matter what balance, and only amounts above the minimum would earn the market rate. Thus, if your balance were $8,000, you would earn 5.25 percent on $1,000 and the higher rate only on $7,000. Because the blended method is obviously less attractive than the tiered, you should find out which method is used before opening a money market account.

Safety vs. Yield
Money market accounts had their origin in the 1970’s after bank depositors were attracted by money market mutual funds. In those inflationary times, the money market funds were paying interest rates as high as 17 percent—in contrast to the 5.5 percent to which banks were restricted by law. Faced with the withdrawal of billion of their depositors dollars, the banks lobbied successfully for permission to offer money market accounts.

In their competition with the money market mutual funds, however, the banks can offer potential depositors only two advantages safety (because market accounts are usually protected by federal deposit insurance, whereas money market mutual funds are not) and proximity (because a local bank may be more convenient for transactions than a distant money market fund).

Bearing in mind these differences, before deciding to open a money market account you should consider carefully whether a money market mutual fund, which is likely to pay you a significantly higher interest rate on your entire balance and which is regarded by most authorities as safe, might be a preferable investment, especially for substantial balances.

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August 29, 2007 | Savings Accounts, Banking |

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