Cash is King once again!
Interest rates on savings — whether for cash stashed in money market mutual funds, bank money market accounts or certificates of deposit (CDs) — are hitting levels last seen in the early 2000s thanks to the Federal Reserve hiking interest rates. Until recently, CD’s and money market funds didn’t produce enough returns to lure investors away from the stock market or depositors away from savings accounts. For the last 10 years, the S&P 500 had an average yearly return of 9.82%.
However, now these savings vehicles are earning up to 5.25% in safe and guaranteed returns causing people to re-evaluate where they park their hard-earned cash.
Let’s dive into the differences between a CD and a Money Market fund:
A CD is a time deposit (3 months, 6 months, 12 months, etc.) offered by banks and credit unions that pays you a fixed percentage. The investor agrees not to withdraw the funds for the specified term in exchange for a higher interest rate. They are easy to get into via your local bank.
Pros:
Fixed Interest Rate: CD offers a fixed interest rate for the agreed-upon term, providing predictability in returns.
Low Risk: CDs are insured by the Federal Deposit Insurance Corporation (FDIC) in the US, providing a high level of safety for the invested funds.
Easy to Understand: CDs are straightforward and simple investment products, making them suitable for risk-averse investors.
Cons:
Limited Liquidity: Access to your funds before the maturity date can result in penalties or loss of interest.
Lower Returns: Generally, CDs offer lower potential returns compared to other investment options like stocks or mutual funds.
Inflation Risk: The interest earned on a CD may not keep pace with inflation, potentially reducing the purchasing power of your money over time.
A Money Market fund, however, invests in high quality, short-term investments, such as U.S. Treasury bills, as well as, certificates of deposit, and gives you the current market rates less a management fee. Think of them as loans that pay the investor interest that can be used to store cash that’s needed in less than five years such as an emergency fund, wedding costs, medical costs or a down payment for a home. Some money market funds are currently yielding up to 5.25 percent. Money market funds can be purchased through various online platforms including Fidelity, Vanguard, Charles Schwab, and TD Ameritrade.
Pros:
Liquidity: Money market funds offer high liquidity, allowing investors to easily access their funds by selling shares or making withdrawals.
Diversification: These funds typically invest in a variety of short-term, low-risk instruments, providing a level of diversification.
Better Returns than Savings Accounts: Money market funds usually offer higher interest rates compared to traditional savings accounts.
Cons:
Low Returns: While money market funds provide stability and liquidity, they generally offer lower returns compared to riskier investments like stocks.
Not FDIC Insured: Unlike CDs, money market funds are not FDIC insured.
Interest Rate Risk: Changes in interest rates can affect the fund's yield and returns.
In summary, CDs provide a fixed interest rate with guaranteed principal but limited liquidity (ability to access your money) and lower returns. Money market funds offer higher liquidity, some level of diversification, and potentially higher returns than traditional savings accounts, but they come with interest rate risk and are not FDIC insured. It all comes down to what your personal needs are for the cash you’re looking to park.
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