Broker Check

Understanding Money Markets

| June 28, 2023

As interest rates have increased, many banks have been slow to increase the interest rates that they pay on customer deposits. In addition, the banking turmoil earlier this year has caused many investors to look for saving alternatives to earn more interest in a low-risk investment. This has caused some savers to move their money from bank money market deposits to investment money market funds. However, there are differences in these investments that should be understood before making the switch.

The definition of a money market is a deposit or investment that trades in short-term loans. Money markets are designed to maintain their value and pay interest periodically without any fluctuation in the principal value. In this way bank and investment money markets are very similar. However, the risks can be different.

To start, bank money markets are typically covered by FDIC insurance whereas investment money markets are not. While it is rare that investment money markets lose value it did happen in limited cases during the financial crisis. Investment money markets often offer higher interest rates than bank money markets, but this is compensation for giving up the FDIC insurance coverage. Some sponsors of investment money markets attempt to overcome this issue by offering government money markets which primarily invest in short term US government bonds. These funds often offer yields that are slightly lower than other investment money markets but are considered lower risk due to the strong credit rating of the US government and the perceived low risk of default.