Investing in Your 20s and 30s: Money Market Funds and Savings Account Returns - dummies

Investing in Your 20s and 30s: Money Market Funds and Savings Account Returns

By Eric Tyson

Be sure to keep your extra cash that awaits investment (or an emergency) in a safe place, preferably one that doesn’t get hammered by the sea of changes in the financial markets. By default and for convenience, many people keep their extra cash in a bank savings account, which tends to pay relatively low rates of interest. Banks accounts come with Federal Deposit Insurance Corporation (FDIC) backing, which costs the bank some money.

Another place to keep your liquid savings is a money market mutual fund. These funds are the safest types of mutual funds around and, for all intents and purposes, comparable to a bank savings account’s safety. Technically, money market mutual funds don’t carry FDIC insurance. To date, however, only one money market fund has lost money for retail shareholders (and in that case, it amounted to less than 1 percent).

The best money market funds generally pay higher yields than most bank savings accounts (although this has been less true in recent years, with low overall interest rates). When shopping for a money fund, be sure to pay close attention to the fund’s expense ratio, because lower expenses generally translate into higher yields. If you’re in a higher tax bracket, you should also consider tax-free money market funds.

If you don’t need immediate access to your money, consider using Treasury bills (T-bills) or bank certificates of deposit (CDs), which are usually issued by banks for terms such as 3, 6, or 12 months. The drawback to T-bills and bank certificates of deposit is that you generally incur a transaction fee (with T-bills) or a penalty (with CDs) if you withdraw your investment before the T-bill matures or the CD’s term expires. If you can let your money sit for the full term, you can generally earn more in CDs and T-bills than in a bank savings account. Rates vary by bank, however, so be sure to shop around.