What Are the Risks of a Money Market Account?
Learn about the safety and potential downsides of money market accounts. Understand key distinctions and their varying protections.
Money market accounts combine features of traditional checking and savings accounts. They offer account holders a balance between earning interest and maintaining ready access to funds. These accounts serve as a low-risk option for managing liquid assets, providing a stable environment for funds and allowing for transactional flexibility.
Core Features of Money Market Accounts
Money market accounts, offered by banks and credit unions, function similarly to savings accounts, providing liquidity features. Account holders can write a limited number of checks, make debit card purchases, or initiate electronic transfers. Interest earned on the balance is usually variable, changing with market conditions, and is commonly calculated daily and credited monthly.
Financial institutions invest pooled deposits from money market accounts into short-term, highly liquid debt instruments. These investments include U.S. Treasury bills, certificates of deposit (CDs), and commercial paper, considered low-risk due to their short maturities and high credit quality. A money market account differs from a money market fund, which is a mutual fund investing in similar securities but operating under a different regulatory framework. While both aim to provide stability and liquidity, their structures and protections differ.
Understanding Potential Value Fluctuations
Funds held in a money market account are subject to economic factors that can influence their value. Inflation risk is a consideration; a sustained increase in the general price level can erode purchasing power, even if the nominal principal in the account remains stable. If the interest rate earned on a money market account is lower than the inflation rate, the real value of the money decreases.
Money market accounts feature variable interest rates, meaning the returns they offer can fluctuate with broader economic conditions and central bank policies. When the Federal Reserve adjusts interest rates, the rates offered by money market accounts typically follow suit. While these fluctuations directly impact the return on deposited funds, the principal amount in a bank-offered money market account generally remains stable and does not decline due to interest rate movements.
A distinction exists between money market accounts and money market funds when considering principal stability. Money market funds, which are investment products rather than bank deposits, are not guaranteed against principal loss. Although uncommon, a money market fund’s Net Asset Value (NAV) could theoretically fall below $1.00 per share, an event referred to as “breaking the buck.” This could occur if the value of the fund’s underlying investments declines significantly due to credit defaults or extreme market volatility. While bank money market accounts strive to maintain a constant principal value, money market funds carry this inherent risk of principal fluctuation.
Regulatory Protections and Account Insurance
Money market accounts offered by banks are subject to specific regulatory protections. These accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up to the standard maximum deposit insurance amount, currently $250,000 per depositor, per insured bank, for each account ownership category. This insurance covers both the principal amount deposited and any accrued interest, protecting account holders against the risk of bank failure.
Money market funds, which are investment products, do not carry FDIC insurance. They are not protected against a loss in value of their underlying securities. While these funds are generally managed to maintain a stable value, they are not guaranteed by the U.S. government against investment losses.
For money market funds held with a brokerage firm, there may be protection from the Securities Investor Protection Corporation (SIPC). SIPC protects customers against the loss of cash and securities held by a failed brokerage firm, up to $500,000, including $250,000 for cash. However, SIPC coverage does not protect against a decline in the market value of the securities themselves, only against the failure of the brokerage firm holding the assets.