Savings lies at the heart of the Financial Independence and Retiring Early (FIRE). Indeed, doing the “saving” is the most crucial part if you want to reach financial independence. However, where you park the money is also vital.

Whether saving for a rainy day, a home purchase, your child’s education, or accumulating money for long-term investments, choosing where to store your money can have a meaningful impact on your future finances.

This article will cover the difference between two common options: savings accounts and money market funds. And no, it’s not as simple as comparing interest rates.

This article is for you if you’ve been pondering where to store your hard-earned cash.

Understanding Savings Accounts

Defining the Savings Account

Savings accounts are one of the fundamental deposit accounts available within banks and credit unions. These accounts serve as the standard “safe repository” for your funds while still allowing you to earn modest interest (historically very modest).

Interest for such accounts is typically expressed as an Annual Percentage Yield (APY), reflecting total annual interest, ignoring the effects of compounding. Even with the recent rate hikes, the average APY on such accounts remains low – as of August 2023, the moderate stands at 0.56% bank rate. However, there are plenty of online banks that are now offering somewhat more competitive rates.

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Advantages of a Savings Account

1. Security through FDIC or NCUA Insurance

Savings accounts are generally considered very secure (at least up to $250,000 per institution). This is because savings accounts typically come with robust coverage from either the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). These agencies ensure that deposits, up to $250,000 per account holder, remain insured even in the event of a financial institution’s failure. For many, this blanket insurance provides a much-needed peace of mind, making savings accounts the ideal choice for those who strictly prioritize the security of their funds.

2. Accessibility and Flexibility

Unlike money market accounts, savings accounts don’t typically have significant minimum balance requirements. This ensures access for a wide range of savers – including those just getting started out.

In general, you can make unlimited deposits and several withdrawals free of charge every month (depending on the limits imposed by individual financial institutions), providing enhanced flexibility to manage your finances.

Whether accumulating the proverbial “rainy day” fund or planning for a short-term objective, a savings account can be an extremely important and flexible tool – albeit with a modest rate of return.

3. Competitive Savings Options

The savings account landscape has changed in recent years. Given the low APYs offered by traditional banks, many online banks and credit unions have popped up now offering APYs that outpace conventional brick-and-mortar banks.

Undoubtedly, this rise in competition benefits savers, but brick-and-mortar banks with traditional savings accounts still have their place as some consumers prioritize the convenience of utilizing physical banks.

An Empower Personal Cash Account offers 4.70% interest as of  August 2023. It also offers direct deposit, and requires no minimum balance. It can be paired with a traditional checking account for bill pay, and you can make unlimited transfers. See here for all the details on an Empower Personal Cash Account.

Another great option for competitive savings is A Betterment Cash Reserve account. They offer unlimited withdrawals and an interest rate of 4.75% in August of 2023. There’s also no minimum balance, and there are no daily withdrawal limits. You can learn more about the Betterment Cash Reserve cash management account here.

Finally, As of August 2023, CIT Bank is offering over 5% interest on their Platinum Savings account as long as you carry a minimum balance of $5,000.

Limitations of a Savings Account

1. Limited Interest Earnings

The most significant drawback of savings accounts compared to money market funds is their low interest rates.

In today’s environment, not only does this mean that your money won’t be growing significantly over time, but on the contrary, you are likely to lose value over time due to inflation. Suppose the primary goal of your account is to accumulate wealth over a long period of time, as opposed to having some funds for liquidity convenience. In that case, a savings account is probably not the optimal choice.

2. Access Constraints

Savings accounts are quite liquid, but if you are looking for maximum liquidity, they may still be constrained compared to a checking account. For example, to withdraw funds from a savings account, you may need to transfer into a checking account and then use an ATM card. Some savings accounts also don’t offer online banking, check services, or debit cards, which can further restrict your access. Although these liquidity limitations exist with savings accounts compared to checking accounts, they are typically worse with a money market fund.

Understanding Money Market Funds

Unpacking Money Market Funds

What is a money market fund? It’s a type of mutual fund that invests mostly in short-term, high-quality securities such as treasury bills, CDs, commercial papers, and repurchase agreements. These funds pay dividends based on the interest earned from the underlying securities listed above.

The dividend rate on these money market funds is known as the 7-day yield, and it represents the annualized dividends paid in the past seven days. Currently, several money market funds are paying ~5% 7-day yields, which is a considerably more attractive rate of return than the average savings account rate.

Advantages of a Money Market Fund

1. Competitive Interest Rates

The primary reason that most investors may choose a money market fund over savings accounts is the greater returns available within money market funds.

Although these rates can vary depending on market conditions, they earn some spread over the bank account rates. These rates are also not exceptional, but they are more likely to keep up with or even outpace inflation. If you’re looking to hold some money in cash for upcoming purchases and like to maximize interest earnings, money market funds are likely a great option.

2. Versatile Access Options

While not typically seen as liquid as a savings or checking account, money market funds are relatively liquid.

Investors can transfer funds online or redeem shares. Many money market funds now have check-writing capabilities and debit cards, making them arguably more liquid than most savings accounts.

However, along with savings accounts, money market funds are typically limited to several withdrawals because money market accounts fall under Federal Reserve Regulation.

Banks may limit the number of withdrawals you can make in any one statement cycle —generally up to six monthly withdrawals. Exceeding the limit is likely to incur a per-withdrawal fee.

3. Stable Net Asset Value (NAV)

One of the distinguishing features of money market funds compared to other mutual funds is their stable net asset value (NAV) per share, typically set to $1. This means you can expect not to lose money while holding assets in a money market account. They effectively do not have price volatility.

Said another way, your initial investment is preserved, and you can expect to receive what you initially put in. This stability makes money market funds attractive for people who want an alternative to cash or bank accounts that earn a competitive yield.

Limitations of a Money Market Fund

1. Lack of FDIC or NCUA Insurance

Unlike savings accounts, money market funds lack FDIC or NCUA insurance. That means they don’t have the same level of protection as savings accounts within banks or credit unions. That said, money market funds do have some level of protection in the form of SIPC protection.

SIPC, FDIC, and NCUA insurance differ in several meaningful ways. The differences between these forms of insurance are examined thoroughly in another one of the Physicians on Fire articles here. I have taken a graphical excerpt from that article to illustrate these differences more clearly.

2. Fees and Expenses

Although money market funds generally return more than savings accounts, it should be noted that some fees associated with them are not associated with savings accounts.

For example, money market funds charge expense ratios, which should be compared against their returns. These fees can diminish your returns, although published yields typically deduct the fund’s expense ratio and report the interest rate net of fees.

Savings Account and Money Market Fund Compared

Choosing between a savings account and a money market fund hinges on several variables, including individual preferences, financial goals, and risk tolerance. To make an informed decision, consider the following factors:

1. Interest Rates and Potential Returns: If your primary goal is to find the maximum interest rate for your liquid savings, money market funds will be the better option than savings accounts. However, you should consider the fees and expenses associated with the different options. Also, remember that money market rates can change frequently, while interest rates on savings accounts are more stable.

1. Access and Liquidity Needs: Return isn’t the only consideration when you are choosing between savings accounts and money market funds – although many money market funds now have debit cards and check writing capabilities, as mentioned above, they still have constraints on the number of withdrawals that can be made per month without incurring penalties.

1. Safety and Risk Tolerance: If your biggest objective is safety and security, you may want to use a savings account. FDCI and NCUA insurance offer broader insurance coverage than comparable SIPC coverage in money market funds. This doesn’t mean that SIPC is worthless or that money market funds are high risk – drawing an advantage to savings accounts is based on a slight and somewhat theoretical/untested edge that savings account insurance maintains.

1. Financial Goals: Your financial objectives are pivotal in this decision-making process. Suppose you are saving for short-term goals, an emergency fund, or a vacation that you might need to access relatively soon. A savings account’s liquidity and stability might be more suitable. On the other hand, if you are saving for medium-term goals, such as purchasing a vehicle or home renovation, a money market fund’s potential for higher returns might align better with your objectives.

1.  Investment Horizon: Yes, money market funds earn higher returns, but if you are only investing for an exceptionally short period of time, you will be splitting hairs. 5% on an annual basis vs 1% can be lost in the wash if you plan to use the funds in the next few weeks. However, if you are planning to hold the assets for an extended period, years of compounding at higher rates of return is quite powerful, as we all know.

Final Thoughts

Savings accounts and money market funds are two powerful financial tools. Each option has benefits and drawbacks; the best choice depends on your unique financial situation and preferences.

When choosing between a savings account or a money market fund, the important thing is to keep your individual goals, risk tolerance, and access requirements in mind.

Ultimately, whether you opt for a savings account or money market fund isn’t as crucial as saving itself when achieving financial security. As long as you have a savings strategy and stick with it, you’re already well on your way to financial success.

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