If you have a personal finance book on your shelf at home, there is a good chance that the author recommends you put your emergency fund savings into a money market account.
Historically, that was good advice as money market accounts have offered higher interest rates than either savings accounts or checking accounts.
However, the opposite has been true for at least the last couple of years.
Right now, some of the money market funds that are typically the best performers are averaging a 7-day yield of between .15% – .05%.
On the other hand, bank savings accounts are paying as much as 1.45% (Nationwide Bank) followed closely with a 1.39% from Ally Bank (rates current at the time of publication, please see respective banks for current rates).
Personally, I think this trend is going to continue for some time. (See comments below about changes to rules for money market funds.)
Let’s look at money market fund basics and savings account basics.
What is a Money Market Account?
As with all other investment opportunities, there are always options that should be looked into before you make your final decision, such as the Discover Money Market Account, to name one.
Once all options have been explored, you should be able to determine which is best for your needs.
Money in a money market is easy to access (liquid). This is important for the money you keep in an emergency fund.
Most money markets give you check-writing privileges, making accessing your money easier. In addition, with a little shopping, you should be able to find a money market fund without fees.
It is important to note that a money market account differs from a mutual fund. This is a common misconception among new investors, so you must understand that the two are different.
A money market deposit account is FDIC insured up to $250,000, which guarantees your emergency fund against a bank failure.
In 2010, the U.S. Securities and Exchange Commission updated rules for money funds. These changes make such investments more secure (theoretically) but also limit the potential yields of the money market funds. Thus, it seems likely that these changes will reduce yields.
With a money market fund, the Interest is a variable rate. This means it will change based on performance.
The money market managers do their best to keep the cost at $1 per share and share any of the additional income through interest payments.
Advantages of a money market account: Safety and ease of access (liquidity).
What is a Savings Account?
Money in a savings account is very easy to access (liquid), which is important for an emergency fund. Depending on your bank, you can typically transfer those funds to a checking account or easily withdraw the money at the bank or using an ATM.
Interest rates at banks do change, but they are fixed because when they set a rate you know you will get that rate until the rate either increases or decreases.
Many banks keep their interest rates for their savings accounts similar to competitors, which may give you more options for your emergency fund savings.
Money in a savings account is FDIC insured up to $250,000.
When shopping for the best savings account, you can typically get the best interest rates from an online account. Here are some of the best savings account interest rates.
Advantages of a savings account: Safe, easy to access (liquid), and competitive interest rates.
Can You Have Both a Money Market Account AND Savings Account?
If the hassle of changing banks and opening a savings account to close it later if money market yields improve does not sound appealing, then you have options.
Call your current money market fund holder and ask about the minimum required balance (without fees).
Keep the minimum amount in your money market fund and open a new savings account. Keep both account types open so you can switch back and forth if interest rates change. You only need to keep the account minimum in the account with the lesser interest rate. This maximizes your earned interest.
This way, you are in a position to easily be able to take advantage of some of the highest interest rates.
Should You Keep Your Emergency Fund in a Savings Account?
In my experience, opening a new savings account online takes about 20 minutes.
Here’s what you need to figure out when comparing money market accounts and savings accounts:
What is your current interest rate on your money market account?
How much more interest could you earn if you switched to a savings account?
Based on your account balance, how much more money would you have at the end of one year. Take that number and ask if it is worth 20 minutes.
In general, if you have an account balance of around $5,000 in a money market account, you will be better off switching to a savings account. But be sure to do your own math.
In my case, I have my emergency fund in an account with Capital One 360. This account is linked to a checking account with Capital One 360, so I can instantly transfer money from my savings account into the checking account and then write a check.
Do you think a money market or a savings account is the best place for an emergency fund?