One of the most significant drawbacks of investing is the risk often associated with most, if not all, forms of investment methods. From stocks to bonds and other forms of investments, everything carries some form of risk that some people cannot bear. If you would rather not worry about volatile stock portfolios and easily inflated bonds, you may choose to invest your money in money market accounts.
These accounts present a safe and somewhat easily accessible means of keeping your money. However, not everyone completely understands the intricacies of maintaining money market accounts. As such, many investors make some crucial mistakes when dealing with these accounts. This article discusses five of these mistakes and how you can avoid them.
What Are Money Market Accounts?
Money markets are similar to other savings accounts that people hold in credit unions and commercial banks. Like other savings accounts, money market accounts are deposit accounts. People open money market accounts with banks or credit unions to save money on a short-term basis. When the market gets especially volatile, many investors run towards the safety provided by money market accounts.
Before you open a money market account, there are some factors you must consider. First, money market accounts often come with a required minimum balance for account holders. If you go below the minimum, you will have to pay some additional charges. In addition, the Federal Deposit Insurance Corporation insures balances of up to $250,000.
A large bulk of money market accounts come with checkbooks and debit cards for transactions. However, these transactions have a limited number of six electronic payments and transfers every month. This is not to say that you will not be able to access your balance after making six transactions within a month. You will only have to incur additional charges. This rule is stipulated in the Federal Reserve Regulation D.
It is also important to note that money market accounts attract interest. Though you should not expect something very huge, interest rates on MM account usually surpass those on traditional saving accounts. The interest typically comes from returns on investment in low-risk funds such as Treasury bonds.
Now that you know what money market accounts are, here are the common mistakes investors make when dealing with these accounts.
Money Market Accounts Vs. Money Market Funds
Many people mistake money market accounts for money market funds. However, they are two different financial instruments and should always be taken as such. A money market fund is a mutual fund that generally has low returns and low risks. Money market funds have distinct methods of investment. They often invest in liquid assets and, in the short term, high credit rating debt-based securities.
Examples of money market funds are prime money funds and Treasury funds. While the former invest in floating-rate debt and non-Treasury securities, the latter invest in bills, bonds, notes, and other standard U.S. Treasury-issued debts.
However, money market funds are not insured by the FDIC, unlike money market accounts. The reason for this is the fact that these funds depend on current market interest rates and remain only an investment product. While many attach the security of money market accounts to money market funds, it is a mistake you should avoid getting the best of your investments.
Money Market Accounts Can Outpace Inflation
Another common mistake is that investors believe that money market accounts do not bear inflationary risks. If you are looking towards protecting your money against inflation, especially in the long term, money market accounts might not be your best bet. However, your money will still attract interest that may mitigate the effect of inflation.
For example, 2020 saw an inflation rate of 1.36%, with a 20-year historical average of 2.1%. But the average interest rate on the money market account is below 60%. This example shows that the interest on money market accounts is generally lower than the rate of inflation. As such, it will not completely safeguard your money against inflation. If inflation drops below the 20-year historical average, banks pay lower interest on MM accounts.
The High the Balance, the Better
As stated earlier, inflation may negatively affect the usefulness of money market accounts. That is why it is unwise to have a high balance in your money market account. Though MM accounts have required minimum balances, it is unwise to keep too much money in them. You have to strike a balance to reap the most of your investment.
Experts recommend placing six to twelve months of your expenses in money market accounts. This balance can be used for health emergencies and other unforeseen financial emergencies. If your balance is higher than the recommended balance, you may be losing out on other investment opportunities with better returns.
Pile it All up in One Money Market Account
One of the most common behaviors of investors is to leave their money sitting in a money market account with significantly low-interest rates. The reason for this behavior is because many people naturally believe it is best to hoard cash, especially during times of economic crisis and inflation. Many investors keep their money in money market accounts and other traditional savings account instead of investing in a more risky and profitable venture.
Every investor should note that this habit negates everything that the investment world preaches. Every investment comes with a risk. With proper research and expert monitoring, many people are able to diversify their investment portfolios without problems. Instead of just keeping your money in these traditional savings accounts, consider diversifying your investment portfolio for better opportunities.
With diverse investment comes less risk and better opportunities to multiply your money. It is only when you can overcome that inborn desire to hoard money and pretty much other resources that you become a true investor. It is also important that you note that hoarding might have worked during the Great Recession, but modern problems call for modern solutions.
Go Over the Insured Limit
While some people fail to diversify by putting all their money in different money market accounts, others fail to diversify by putting all their money in one money market account. The people in the latter group can easily surpass the FDIC insured limit of $250,000. This mistake is a common one that all investors should avoid.
Rather than put all of your eggs in one basket, consider having multiple accounts to ensure all your money is insured. This suggestion also goes for families and estates with a lot of funds in MM accounts. One way to diversify your MM accounts is by dividing your money into three parts. The first part can be saved for the short term, usually one to three years. The second part can be saved for four to ten years. This type of saving is known as mid-term saving. Finally, you can also have a long-term saving of over ten years.
Choosing this investment approach comes with many advantages. First, it makes it easier to separate and work towards achieving your short-term and long-term goals. It also helps build discipline, especially when you are saving for the long term, which will generally be longer and take more effort. You can also use this model for investing outside the money market.
You can invest long-term in an annuity, life insurance, and bonds. Doing this gives you a diversified investment portfolio and helps you avoid a reduction in the value of your money if you keep it in cash. Also, you can invest short or mid-term in other investment vehicles that give you easier access to your money, just like MM accounts but have higher risks and returns. You have to be able to give your investment time to grow and bear the market volatility.
If you keep your money moving as much as you can, instead of placing it in a savings account, you would have increased chances of outpacing present and future inflation and protect your money from losing value. Whatever it is you do, ensure you completely understand what you are going into to make the best decision for yourself and your finances.
Money markets present a great way to keep emergency funds and earn a small percentage of your money. However, your money is more likely to grow with a more diversified investment portfolio.