4 key differences between money market funds and high-yield savings accounts

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They are both very safe and offer liquidity, according to Greg McBride, chief financial analyst at Bankrate. They generally serve as repositories for emergency funds or savings earmarked for the short term, perhaps to buy a car, home or vacation, said Kamila Elliott, a certified financial planner and CEO of Collective Wealth Partners, based in Atlanta.

That’s because money market funds and high-yield savings accounts are stable and allow for easy access — two essential traits when saving money you can’t afford to lose and might need in a pinch, said Elliott, a member of the CNBC Advisor Council.

“They’re both very, very safe and offer liquidity,” said Greg McBride, chief financial analyst at Bankrate.

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Plus, their yields are often higher than those of a traditional bank savings account. The yields on these accounts have risen dramatically over the last year and a quarter as the Federal Reserve increased its benchmark rate to combat inflation. Many are paying yields above 4% and 5% after years of sitting near rock bottom.

By comparison, traditional savings accounts pay a paltry 0.54%, on average, as of Aug. 28, according to Bankrate.

And consumers don’t necessarily have to make an either-or choice.

“Plenty of investors have both,” McBride said.

Here are some key differences.

1. Risk

High-yield savings accounts are bank accounts, often offered by online institutions.

That means they carry Federal Deposit Insurance Corp. (FDIC) insurance. This government-backed coverage insures bank deposits up to $250,000 per account.

Money market funds, on the other hand — while also generally safe — are a bit riskier, experts said.

They are mutual fund investments, offered by brokers and asset managers. These funds hold short-term, safe securities, which can be U.S. Treasury Bonds or high-grade corporate bonds, depending on the funds. Money funds have only “broken the buck” a few times in history — perhaps most notably during the 2008 financial crisis, when the Reserve Primary Fund’s share price fell to 97 cents, triggered by the Lehman Brothers bankruptcy.

From 2007 to 2011, at least 21 other funds would have broken the buck without a capital infusion from the funds’ sponsors, according to a 2012 report by the Federal Reserve Bank of Boston.

Since they aren’t bank accounts, money funds don’t carry FDIC insurance. Money funds do have SIPC protection. This covers cash and securities losses up to $500,000. However, SIPC doesn’t protect against investment loss — it restores customers’ holdings during the liquidation process but doesn’t restore value if there was a decline.

Investors who prefer money market funds may opt for government money market funds, which carry slightly less risk, Elliott said. They invest primarily in U.S. Treasurys, rather than corporate debt. Earnings

Money-market funds pay slightly more interest than high-yielding savings accounts. Elliott confirmed this. This yield is calculated as the average annualized return of a fund for seven days. This yield is net of any investment fees that reduce it. )

High-yield savings accounts are currently paying up to 5.25%, McBride said.

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While each tend to track movements in the Federal Reserve’s benchmark interest rate, their yields climb higher for differing reasons. Experts say that the Fed directly influences money market funds, but that banks raise payouts in order to increase customer deposits, which they then loan out to earn money. Higher rates generally attract more deposits.

Current rates are just a “snippet in time,” however, McBride said. He said that high-yielding accounts were “measurably higher than what money funds paid” from 2008 to 2021. Some predict that the Fed will begin cutting interest rates in 2013.

3. Account minimums

High-yield savings accounts generally don’t carry minimum deposit requirements — and if they do it’s a relatively small amount, McBride said.

Money funds tend to require a minimum investment that exceeds $1,000, he said. McBride says that this is not something everyone can do. He added that consumers should be cautious about allowing their account balance to fall below a specific level, as they could incur a fee.

4. Taxes

Interest income for both high-yield savings and money funds is taxed as regular income, experts said. Those rates reach up to 37% at the federal level.

However, some money market funds may carry tax benefits, said Eric Bronnenkant, head of tax at Betterment. It’s important for consumers to consider their net yield after taxes, he said.

Specifically, interest income from money funds that hold U.S. Treasury bonds may get a break on state and local — though not federal — taxes, Bronnenkant said.

In general, states let investors prorate the portion of income related to U.S. government debt, he said. Bronnenkant explained that, for example, if a money-fund held 25% Treasury bonds, and 75% commercial bonds, then 25% would be exempt from state and local tax. (There are exceptions: California, Connecticut and New York require that at least half of a fund’s assets be invested in U.S. government bonds to qualify for a tax break, Bronnenkant said.