Money Market Account

What It Means

A money market account, or money market deposit account (MMDA), is a form of bank account that imposes strict rules regarding balance size and the number of withdrawals that can be made each month. In exchange, banks pay money market account holders interest (a fee owed to those who lend money) at a higher rate than they do the holders of other account types.

Banks and other savings institutions, such as credit unions and savings and loan associations, take in money from account holders in the form of deposits, but they do not simply store this money in their vaults. They lend it to other borrowers or invest it with the intent of making profits for themselves. Thus, when you deposit money in a bank, you are lending the bank money. In return for this loan, the bank pays you interest. Different types of bank accounts pay interest at different rates. In general, you can expect to collect interest at higher rates the larger and more stable your bank balance is, since large, stable pools of money make it easier for a bank to invest profitably.

Basic checking accounts, which offer easy and instant access to deposited money, pay little or no interest and have few restrictions. If you open a basic checking account, you can generally keep your balance as high or as low as you like, and you can expect to withdraw money (for example, by writing checks, transferring funds online, or making withdrawals from automated teller machines, known as ATMs) as often as you like. The resulting instability of checking account balances restricts the kinds of investments banks can make using this source of funds. Savings accounts, on the other hand, are not meant to be used for ordinary transactions. Some limitations are usually placed on withdrawals made from savings accounts; therefore, these accounts provide banks with a more stable stream of money than checking accounts, and they pay higher interest rates.

A money market account is a form of savings account. If you open a money market account, you will probably be required to maintain a relatively high balance (usually ranging from $100 to $2500) at all times, and you will probably be allowed to make only a small number of withdrawals per month (usually around six). Because these rules result in higher and more stable account balances, they make it easier for banks to invest profitably. In exchange, banks pay higher rates of interest on money market accounts than they do on most other types of accounts.

When Did It Begin

Money market accounts came into being as a result of the Garn-St. Germain Depository Institutions Act of 1982. This act consisted of many provisions which worked together to deregulate the banking industry, primarily in the hope of helping the numerous struggling savings and loan associations across the United States. Savings and loan associations (or S & Ls) were failing in part due to government restrictions on the types of investments they could make. Garn-St. Germain removed some of the key restrictions on S & Ls and reformed other aspects of the banking industry.

Prior to the Garn-St. Germain Act, there had been limits on the amount of interest a savings institution could pay depositors. By allowing savings institutions to offer money market accounts, a form of savings account with no interest-rate ceiling, the Act made it easier for them to attract deposits. The Garn-St. Germain Act failed to save S & Ls from financial disaster, but money market accounts became a lasting feature of the banking industry.

More Detailed Information

Money market accounts offer a combination of financial gain (through interest payments) and liquidity (the ability to convert account balances into cash easily). This combination allows them to fill an important need in the financial life of individuals, families, and businesses.

At one end of the financial spectrum, a basic checking account offers little if any financial gain, since most such accounts do not pay interest, but this is offset by an extremely high level of liquidity. Checking accounts are ideal for storing the money that you need to pay your ordinary expenses, but it is not advisable to use checking accounts for saving money. If you have money left over after paying your expenses each month, there are better ways of saving and investing those excess funds than in a checking account.

At the other end of the financial spectrum, stocks (shares of company ownership), offer the possibility of large financial gain (as company owners, stockholders earn money when a company prospers) but a comparatively low level of liquidity. To invest effectively in the stock market, it is generally necessary to commit your money for a long period of time. Monthly and yearly fluctuations in stock value can be drastic, but over periods of five or ten years stock gains often outweigh losses and outpace the gains made by other types of investments. If you do not need access to your savings for five or more years, investing in stocks may be a good idea.

Money market accounts fall somewhere in the middle. If you do not need access to your money right away but expect to need it within a year or so, a money market account may be the ideal place to put your savings. If, for example, you are trying to save money to purchase a car or a house six months from now, a money market account might be the best place to put your money in the meantime. You will earn interest each month, but you will have easy access to your money when the time comes to make the purchase.

Financial advisors generally suggest, moreover, that individuals and families always have enough money available (that is, saved in a form that offers a high level of liquidity) to support themselves for three to six months in case of emergency. Money market accounts are among the most sensible places to keep such emergency funds, since they offer sufficient liquidity to deal with any financial demands caused by emergencies while paying interest on your savings until the money is needed.

Added to this balance of financial gain and liquidity is the safety that comes with saving money in a bank, as opposed to investing it in the stock market (or other financial markets), where there are no guarantees that you will not lose your money. The Federal Deposit Insurance Corporation (FDIC), a government agency responsible for guaranteeing the stability of banks nationwide, insures money market account balances up to $100,000. In other words, if you open a money market account with a bank that goes out of business, the FDIC will pay you the full value of your balance as long as it does not exceed $100,000.

Recent Trends

One of the chief attractions of money market accounts is that they pay higher interest rates than other kinds of bank accounts. During the late 1990s and the early years of the twenty-first century, however, all interest rates in the United States were at historically low levels. This was good in many ways. It became easier for many people to take out the loans that they needed to buy homes, and it made business owners more likely to expand their operations using borrowed money. Low interest rates, however, made bank accounts of all kinds less attractive forms of investment than they had traditionally been. In the mid 1980s, for example, a money market account may have paid interest at a rate of around 10 percent. In 2005, by contrast, the average interest rate paid by money market accounts was around 1 percent. Since prices across the economy were generally rising, in the late 1990s and the early years of the following decade, at a rate of around 3 percent a year, saving money in a bank meant losing money.