What to know before choosing.
Fidelity Smart Money
Key takeaways
- Both money market funds and CDs are considered relatively safe investments, potentially providing returns in the form of interest or dividends.
- Money market funds are generally more liquid than bank or brokered CDs.
- Interest rates on money market funds and CDs are influenced by the federal funds rate, which the Federal Reserve raises or lowers in response to inflation and other economic data.
- The interest paid on a money market fund can fluctuate daily whereas the interest rate on a fixed-rate CD remains the same for the term of the CD.
- CDs issued by a bank insured by the Federal Deposit Insurance Corporation (FDIC) are covered by FDIC insurance up to applicable limits, while money market funds are not FDIC-insured.
Looking for a relatively safe place to stash money and trying to decide between a money market fund and certificate of deposit (CD)? "Right now, both are offering great rates for investors looking to invest some of their short-term money," says Richard Carter, vice president of Fixed Income Products & Services at Fidelity Investments. Here's how to figure out which may make more sense for you.
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What is a money market fund?
A money market fund operates in much the same way as other mutual funds: It pools investors' money to buy a basket of securities. But instead of buying stocks, long-term bonds, and the like, a money market fund buys low-risk, short-term debt, such as US Treasury bills or commercial paper, with the objective of preserving principal and daily access to your money.
There are 3 different types of money market funds, each named for what they invest in: government,1prime,2and municipal or "tax exempt."3 Government funds invest in cash, US government securities, and repurchase agreements (to buy a security at a price and sell it back at an agreed-upon price) with US government securities and cash as collateral. Prime funds may invest in the same things but also corporate debt such as commercial paper and CDs. Municipal funds mainly invest in municipal securities and strive for income that is exempt from federal income tax and, in some cases, from state income tax.
A money market fund is an investment product (a security) and should not be confused with a money market account, also known as a bank money market deposit account, which is an interest-earning bank product insured by the FDIC that may come with a debit card or checks and may limit the number of withdrawals in a given time period. A money market fund is not a bank account, and seeks to preserve a $1.00 value per share, but it is not insured or guaranteed by the FDIC or any other government agency. It allows unlimited withdrawals, making it flexible, plus yields may edge slightly higher than rates on money market accounts, so be sure to compare.
What is a CD?
A traditional certificate of deposit obtained directly from a bank typically pays a fixed interest rate over a specified time period. In return for committing to leave your money in the CD for a certain number of months or years, its interest rate is generally higher than what is offered for a regular savings account that you can tap without paying an early withdrawal penalty. (Some banks offer variable-rate or step-up CDs with interest rates that change.) Typically, the longer the investment period, the higher the interest rate you'll earn. If you don't touch your CD until it reaches maturity, you get back your principal (what you paid for it) plus the interest. CDs are issued by banks and are insured by the FDIC up to $250,000 per depositor, per insured bank, for each account ownership category. If offered by brokerage firms, they are known as brokered CDs, which can be bought either as new issues or both bought and sold on the secondary market.4 Some brokered CDs are callable, which means the bank can redeem the CD on a specified date before the maturity date.
What are key similarities and differences between a money market fund vs. a CD?
| Money market fund vs. CD: Key similarities and differences | |||
| Bank traditional CDs | Brokered CDs | Money market funds | |
|---|---|---|---|
| May be appropriate for | Investors seeking potential greater returns on cash who are willing to commit to specific time periods | Investors seeking potential greater returns on cash who are willing to commit to specific time periods | Investors focused on preserving the value of their investment who prioritize access to funds over rate of return |
| Investment period (maturity) | Varies months to years | Varies months to years | No time commitment required |
| Access | Typically a penalty if withdrawn before maturity | A trading fee and potential to receive less in sale proceeds than the original principal (par) amount of the CD | Easily retrieve funds to get cash, pay a bill, or make another investment in your account |
| Growth potential | Limited over the long term, but possible to ladder to diversify across different time frames and rates | Limited over the long term, but possible to ladder to diversify across different time frames and rates | Limited over the long term |
| Current rates & yields | Not offered by Fidelity | Research current rates and yields | Research current rates and yields |
| Earnings rate | Normally fixed for the term | Normally fixed for the term although some brokered CDs can be callable and may be redeemed by the issuing bank before maturity | Normally changes daily |
| Earnings payment | Typically principal and interest returned at maturity | Interest can be paid at various intervals; principal is paid at maturity or on the call date if a callable CD is called by the issuing bank | Dividends accrued daily, paid monthly (plus occasional capital gains) |
| Product insurance or guarantee | FDIC | FDIC | Not insured or guaranteed by the FDIC or any other government agency |
| Potential tax benefits | n/a | n/a | Municipal funds for taxable accounts (e.g., nonretirement) |
| Minimum investment | $0 or more | Typically $1,000 for a single brokered CD; Fidelity also offers fractional CDs with minimums and increments of $100 | $0 or more |
When might a money market fund make sense?
A money market fund may make sense for fast, flexible access to your cash. If you already have an account with a brokerage firm, you may choose to put your cash in a money market fund until you use it to, say, pay a bill or buy a stock or other mutual fund.
When might a CD make sense?
A CD might be a better option if you can keep cash locked up for extended periods. Perhaps you're saving for a big expense such as a home renovation and want to limit risk while earning a fixed rate of interest as long as you avoid early withdrawal penalties. You might be able to lock in a higher rate for a set period before interest rates tumble. "When considering which CD to buy: First determine your holding period, then look for the best rate," suggests Carter.
But a CD with an early withdrawal penalty, or the incursion of trading costs and potential to receive less in sale proceeds than the original principal amount of the CD, may not be the right choice when instant liquidity is important, like with emergency savings. "For this reason, make sure you have enough cash in highly liquid form to cover your typical expenses plus some amount in an emergency fund first before you start contemplating the potential for higher rates available on CDs," says Carter.
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