When it comes to earning more on your savings, money market funds (MMFs) and certificates of deposit (CDs) are often two of the first options savers consider. Both can offer higher returns than a traditional savings account, and both are generally considered lower-risk places to keep your cash. But despite their similarities, these accounts work differently.
If you’re looking for the best place to keep your cash, here’s what you need to know about money market funds versus CDs — and how to decide which option is right for you.
A money market fund is a type of mutual fund that invests your money in short-term, low-volatility assets — meaning there’s very little risk of losing your money. In fact, MMFs are some of the safest types of investments available. They’re designed to preserve capital and liquidity while providing modest interest income.
Money market funds are offered by investment firms and brokerages. When you put cash into a money market fund, the fund then pools money from many investors to buy short-term securities. The interest earned is passed on to investors as dividends. The money pooled in MMFs is typically invested in:
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Municipal bonds
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Treasury bills
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CDs
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High-quality corporate bonds
These securities are all considered low risk because they tend to maintain their value, even when market conditions shift. However, as with other types of low-risk investments, MMFs have fairly low returns, which means they’re not good for long-term investing.
How to compare money market funds
Each brokerage offers different options for MMFs, including several categories you can choose from. How do you compare the accounts and choose which one is best? Here are a few details to look at:
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Type: There are three categories of money market funds: municipal, prime, and government. Earnings on municipal MMFs are tax exempt, but prime and government are not.
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Net expense ratios: The net expense ratio tells you what percentage of your returns will be held by the brokerage to cover fees. The lower the ratio, the more of your earnings you keep.
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SEC yields: Also known as 7-day yields, SEC yields show you what your rate of return would be if you earned the past week’s average payout for a full year.
Currently, Vanguard offers SEC yields up to 3.56% (prime), Schwab offers up to 3.61% (government) and Merrill Edge offers up to 3.65% (prime). Rates are subject to change daily.
What is a CD?
A certificate of deposit is a type of savings account offered by most banks and credit unions that allows you to earn a guaranteed rate of return if you leave your money on deposit for a set period of time. CD terms can range anywhere from 28 days to 10 years, and you can currently find CD rates as high as 4%.
Like MFFs, CDS are low risk. In fact, the only way you can lose money on most CDs is by withdrawing your funds before the maturity date, or the date the CD term ends. When you do this, you usually have to pay an early withdrawal penalty.
Money market fund vs. CD: Key differences
Both MMFs and CDs are very low risk, and rates are higher than most traditional savings accounts.
However, there are enough differences between the two that it’s worth weighing the choice carefully. With MMFs, you’ll have to deal with expense ratios that eat into your earnings, and the interest rates aren’t fixed. By contrast, rates on CDs are generally higher, but you have to leave your money on deposit for a set period of time.
Here’s a closer look at how money market funds and CDs compare:
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MONEY MARKET FUND |
CD |
|
|---|---|---|
|
Interest |
Variable |
Fixed |
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Risk |
Low |
Very low |
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Offered by |
Investment firms |
Banks and credit unions |
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Fees |
Expense ratios, minimum balance fees, transaction fees |
Early withdrawal penalties |
|
Insurance |
Some are insured by the SIPC |
FDIC (or NCUA if held at a credit union) |
|
Are earnings taxable? |
Only municipal MMFs are tax exempt |
Yes |
Read more: How to avoid taxes on CD interest
Money market fund vs. CD: Which is better?
CDs and MMFs can both be useful financial tools. If you have money you’re setting aside for a few months or more, but you also want to earn interest with limited risk, a CD or an MMF can be a good choice.
So, how do you choose the right option? Consider the following.
A money market fund may be the better fit if:
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You want easy access to your cash.
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You’re building or maintaining an emergency fund.
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You think interest rates may stay elevated or increase.
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You’re saving for a goal that’s less than a year away but don’t know exactly when you’ll need the money.
A CD may be the better fit if:
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You know you won’t need the money for a specific period.
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You want a guaranteed return.
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You expect interest rates to decline.
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You want your deposit to be insured by the FDIC.
Read more: Money market fund vs. high-yield savings account
