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Money market accounts are a savings vehicle which pays higher rates than savings accounts. In exchange for these higher interest rates you’ll have restricted withdrawals. These accounts are fairly horrible for handling situations where you need frequent withdrawals. You’ll also have higher minimum balances. A minimum balance of one thousand to three thousand dollars is fairly common. As long as your Money Market Account is not heavily withdrawal restricted, you can easily substitute it for a savings account when creating your emergency fund. A decent amount of withdrawals is 4 a month, some accounts only allow for 3. The best accounts allow for six or more, which is more than enough for an emergency fund.

Savings Vehicle Comparisons

There are many other savings vehicles that offer similar interest rates, but they don’t allow you to withdraw funds frequently enough for you to deposit an emergency fund. Certificates of Deposit are an example. CD’s have a maturity date after purchase. Between the purchase of the certificate and the maturity date you cannot withdraw any cash without incurring a substantial penalty. Your money is locked into the instrument. Savings accounts allow frequent withdrawals, but their interest rate is substantially lower.

Money Market Funds

Money Market Funds pool money from many investors and invest in ultra-short term debts and financial instruments. Their targets have less than 6 month durations. These funds typically have high liquidity and higher interest rates than money market accounts. They can also require higher minimum balances, typically ranging up to $5,000. Money Market Funds allow withdrawals as well, but typically only several hundred dollars or more at once. You can write checks against the balance or debit charges on the account. Otherwise, they function like most mutual funds. You purchase a set of shares at a price, and own a percentage of the fund’s assets.

However, they do have their own set of drawbacks. Since they are indirectly affected by the market prices of the assets they purchase it is possible to lose saved principal. Money Market Mutual Funds are not fit for emergency funds even though Money Market Accounts are. Since they can lose principal, they are also not insured for protection by the Federal Deposit Insurance Corporation. They also have their own explicit and covert costs. Explicit costs include managing fees, marketing costs, operating costs, and other charges deducted annually from the fund. Covert fees are any trading costs for buying and selling the short term investments, which are subtracted from the fund’s returns. Compare fees and costs before deciding on a money market mutual fund. The higher fees are, the more they devour your returns.

Several funds offer a tax advantage that intentionally reduces the taxes paid on your returns. They purchase tax free investments, but many of these investments pay lower compensations. They only benefit you if your tax rate is in a high tax bracket. If you’re not in a high bracket, the benefit from reduced taxation is undermined by the opportunity costs. You could have received higher returns in a normal money market mutual fund, paid taxes on those returns, and received more profit than your tax free money market mutual fund.

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