Why Money Markets are more Flexible than Cds

For investors who are not ready to commit to a long-term purchase in stocks or bonds but have cash they don’t want to leave sitting in a checking or savings account earning little to no interest, there are two obvious choices: certificates of deposit and money market accounts. Each offers certain benefits depending on an investor’s situation.

A certificate of deposit, or CD, is a financial instrument issued to an investor in return for an agreement to leave the money invested for a specified length of time. CDs pay higher interest rates for longer investment periods. While it’s possible to purchase a CD for a period as short as a few months, the interest rate doesn’t really offer much benefit over a savings account unless the time period is a year or more. Most banks require a minimum purchase amount of at least $1,000. A CD is insured by the Federal Deposit Insurance Corporation (FDIC) up to $100,000.

The major limitation to a CD is that the funds are not available to the investor until the term of the CD ends. Some investors build up what is known as a CD ladder by buying CDs with varying maturity dates so some of their funds are near maturity (therefore more accessible) at any point in time. It is possible to withdraw funds from a CD before the maturity date, but it will cost you several months worth of interest in the form of a penalty for early withdrawal.

A money market deposit account (MMDA), on the other hand, is much like a checking or savings account. Money market funds are invested in short-term very liquid investments. Most money market accounts can be opened with little or no minimum deposit, but attractive higher rates are only available to investors who maintain substantially higher balances in their accounts. MMDAs are also insured by the FDIC in most cases, but it’s wise to verify this with the financial institution.

While customers have far more access to money market accounts than CDs, Federal Regulation D limits the number of transactions not made in person, e.g. online, by phone, or automatic, to six per account per month. Some banks restrict the number of withdrawals a customer may make from a money market account in a given time period even further. The money market account offers greater flexibility through easy access to the money, but the price is in the form of a lower return on the investment.

If you consider the old adage that time is money, you will find that it is especially apropos in the banking industry. The longer you are willing to do without your money, the more the bank is willing to pay you for using it.