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Money Market vs. Certificate of Deposit

Which Is Better - Money Markets or CDs - For Your Portfolio?


Market Markets vs CDs

When giving your money to a bank in exchange for interest payments, one of the major choices you will have to face is whether to invest in a certificate of deposit or a money market account.

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Certificates of deposit and money market funds are popular choices for investors in the United States because each offers a unique set of advantages, terms, yields, pricing, conditions, and restrictions.  Depending on circumstances, resources, and your own investment portfolio preferences, either, or both, can work for you when you are looking for a place to earn a relatively secure stream of interest income, but don't want to dive into tax-free municipal bonds or corporate bonds.

In the Left Corner: Certificates of Deposit

Certificates of deposit (or CDs for short) are debt instruments issued by banks and other financial institutions to investors. In exchange for lending the institution money for a predetermined length of time, the investor is paid a set rate of interest. Maturities on certificates of deposit can range from a few weeks to several years, with the interest rate earned by the investor increasing in proportion to the time his capital is tied up in the investment under most yield rate environments.

Pros: The investor can calculate his expected earnings at the outset of the investment. Certificates of deposited are FDIC insured for up to $250,000 and offer an easy solution for the elderly who desire only to maintain their capital for the remainder of their life.

Cons: If the investor opts for a longer maturity and, thus, higher rate of interest, he will lose access to his funds and forego alternative uses of his capital.

In the Right Corner: Money Market Funds

Money markets, on the other hand, are very different.  First, it is important to understand the difference between and FDIC insured money market account at a bank and a non-FDIC insured money market mutual fund offered through a brokerage firm.  They are not the same thing.

A money market account at your bank offers many of the benefits a certificate of deposit does, only it has the added feature of check writing, in most cases.  If you have a larger balance, you might be able to get a slightly higher yield depending on the rates being paid at the time, and you won't have to wait for certain maturity dates to get your hands on your principal.  On the flip side, withdrawals are often limited to a set contractual amount (e.g., no more than 4 withdrawals a year).

Money market mutual funds, in contrast, are pooled mutual funds focused on acquiring portfolios of government t-bills, savings bonds, certificates of deposit, and other safe and conservative financial instruments.  The portfolio manager strives to keep the fund at exactly $1.00 per share so it appears to work like cash, even though it's not.  In times of severe stress or manager error, a money market mutual fund can theoretically "break the buck", though it has been a very rare event, historically.

Pros: Depositing money in a money market is as easy as depositing cash into a savings or checking account. Cash is immediately available for alternative investments if you change your mind and want to put your capital to work elsewhere, in stocks, buying real estate, or even spending it.

Cons: Some financial institutions place a limit on the number of checks that can be drawn against the account in any given month. The rate of interest is directly proportional to the investor's level of deposited assets, not to maturity as is the case with certificates of deposit. Hence, money markets are disproportionately beneficial to wealthier investors.

The Verdict

Although both can be useful, for those who need access to their capital and / or have much higher cash balances, money markets are often the superior choice.  For those who want to time maturities to certain events or benefit from a willingness to lock away savings for a long period of time, certificates of deposit are often the better portfolio selection.

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