'Are money-market accounts and funds the same?'

@Money June 13, 2012: 5:17 AM ET

(MONEY Magazine) -- Are money-market accounts and money-market funds the same thing? -- Ed, Middleburg Heights, Ohio

Not by a long shot. Even though the names are similar and many investors think of them as interchangeable stashes for ready cash and emergency funds, money-market accounts and money-market funds are very different.

And while it might have once been OK to gloss over their differences, in today's post-financial crisis world you need to understand the distinctions between the two, as well as the different levels of security they provide.

A money-market account is essentially a savings account with check-writing privileges that's offered by a bank.

Each bank sets the interest rate that its money-market account pays -- about 0.5% on average lately -- and that rate is usually higher than the yield on regular savings accounts.

As long as the bank is a member of the federal deposit insurance system, its money-market accounts are FDIC-insured, which means you're generally covered up to a limit of $250,000.

A money-market fund, on the other hand, is a mutual fund. It is not a bank account and doesn't qualify for FDIC insurance, even if you happen to get into a money-market fund through your bank.

Money-market funds can invest in the short-term debt of the U.S. government and its agencies as well as in the short-term obligations of domestic and foreign corporations and banks.

The yield on those investments determines how much money-market funds pay. Because short-term interest rates have been scraping along the floor of late, money-market funds these days yield a measly 0.03% or so on average.

Money-market funds are designed to maintain a stable price of $1 per share with each dollar of interest you collect earning you an additional share of the fund.

But there's no guarantee that a money-fund's share value won't sink below $1. And, in fact, after decades of a nearly flawless record of money funds preserving a $1 per share value, in September 2008, the Reserve Primary Fund "broke the buck," or let its share price slip below $1, after suffering losses on Lehman Brothers debt it owned.

That loss, combined with other problems in the credit markets as the financial crisis unfolded, resulted in a number of investment firms having to shore up their money funds.

To prevent a run on money funds, the Treasury Department also created a special program to guarantee the value of money fund assets. That program ended in September 2009.

Since then, the Securities and Exchange Commission has required money funds to tighten their investing standards to reduce the chance of them breaking the buck again.

The SEC and the money fund industry have also been trying to hammer out a number of other reforms. They could include such provisions as allowing money funds' share price to go up and down like any other mutual fund's share price, requiring money funds to hold more capital or having money funds hold back a portion, say 3%, of investor redemptions for 30 days. At this point it's unclear which reforms might eventually be put into place and when.

So what does all this mean for individuals like you who are deciding where to put the cash they want to keep safe for everyday living expenses or as an emergency reserve?

Well, if you want the highest level of yield and safety, money-market accounts are the clear choice.

Granted, unless you're investing pretty large amounts their extra payouts may not amount to a whole lot. The difference between earning 0.5% and 0.03% on $10,000 is just $47 a year, or less than $4 a month.

But even if the yield advantage doesn't create a windfall, you're also getting an investment that's more secure than a money market fund.

That's not to say money funds are unsafe. I think the risk of loss in them is still very low. But the financial crisis has shown that money funds can run into problems during extreme times.

That doesn't mean you should necessarily dump money funds if you own them. I still own money funds, mostly for the convenience of having my ready cash with the same firm that holds my other investments. But I'm aware that I'm paying for this convenience in the form of lower yields and a somewhat elevated (although in my view still small) level of risk.

This could all change in the future. The SEC may enact rules that will make money funds less vulnerable during periods of upheaval while still affording investors easy access to their dough. Or when interest rates start to rise, perhaps money funds will start paying higher rates than money-market accounts, as was often the case before the financial crisis.

For now, though, convenience aside, money-market accounts are the better place to be.

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