Money-Market Accounts and Funds

How it works

A money-market deposit account sits on a bank's balance sheet exactly like a savings account: the bank owes you the money, sets the rate itself, and the balance carries FDIC or NCUA insurance up to the standard limit per depositor, per institution, per ownership category. A money-market fund is a different animal entirely — a registered mutual fund. Your money buys shares, the fund buys short-dated paper, and the interest that paper generates is passed through to you as a dividend that accrues daily and is typically paid out monthly.

SEC Rule 2a-7 dictates what a money-market fund is allowed to hold: high credit quality debt only, a portfolio weighted average maturity capped at 60 days, a weighted average life capped at 120 days, and mandatory daily and weekly liquid-asset buffers. Funds split into three types by what they hold. Government funds stick to Treasuries and repurchase agreements; prime funds add commercial paper and bank certificates of deposit; tax-exempt funds hold short municipal notes. The type held determines both the credit risk taken on and how the income is taxed.

Retail and government money-market funds try to hold a stable $1.00 net asset value. Institutional prime funds and institutional tax-exempt funds are required to float their NAV instead, meaning the share price can move by small fractions of a cent as the underlying portfolio is marked.

A brokerage account's default 'sweep' for idle cash lands in either a money-market fund or a bank sweep program — two structurally different products with different protections, spelled out in the account agreement rather than the marketing name.

What it pays

A bank MMDA pays whatever APY the bank chooses to set, driven by the general level of policy rates and by how urgently that particular bank wants deposits, exactly the way an ordinary savings account works. A fund instead quotes a seven-day yield, shown gross or net of its expense ratio — the net number is what actually reaches a shareholder.

A fund's yield mechanically tracks very short-term market rates: the Federal Reserve's policy rate corridor, the overnight repo rate (SOFR), and short Treasury bill yields, all with a lag of days to a few weeks as the underlying paper matures and rolls into new paper at current rates. That short duration cuts both ways — the yield adjusts upward quickly when rates rise, and downward just as quickly when rates fall.

Prime funds typically yield somewhat more than government funds, compensating for the added corporate and bank credit exposure; that spread can widen sharply during a funding-market panic, precisely when the extra yield is least comforting. Tax-exempt money funds show a lower headline yield that only makes sense compared on a taxable-equivalent basis, not lined up directly against a taxable fund's number.

Costs and taxes

A bank MMDA carries no expense ratio, though it may charge a monthly maintenance fee or an excess-transaction fee if withdrawal limits are exceeded. A money-market fund charges an expense ratio deducted daily from the gross yield the portfolio earns; because the underlying return is already a short-rate return, that fee can consume a large share of what shareholders actually receive.

Fund sponsors sometimes waive part of their fee specifically to keep a fund's net yield above zero when short rates are very low — a waiver that is discretionary and can be withdrawn once conditions change.

MMDA interest and taxable money-fund dividends are ordinary income at the federal level, and MMDA interest is also taxed by the states that tax interest income. Government and Treasury funds pass through a percentage of income earned on direct US obligations, and that portion is often exempt from state income tax in most states; the fund discloses the exact percentage each January.

Tax-exempt money-market funds pay dividends that are generally exempt from federal income tax, with single-state versions available for some large states offering an additional state-tax exemption. Part of that income can still count as a preference item under the alternative minimum tax.

Liquidity and time commitment

MMDA balances are available on demand, frequently with check-writing or a debit card attached, functioning day to day like a checking account with a better rate. Fund shares are redeemed at that day's net asset value, with proceeds usually settling the same day or the next business day depending on the cut-off time and share class.

Following the 2023 SEC amendments, institutional prime and institutional tax-exempt funds must impose a mandatory liquidity fee on shareholders when daily net redemptions exceed a specified share of fund assets, while the old discretionary redemption gates were removed from the rulebook entirely.

Neither product has a maturity date, a lock-up period, or an early-withdrawal penalty; the cost of that flexibility is a rate that resets continuously rather than locking in. The only real effort required is confirming which product a given cash balance is actually held in — a brokerage sweep default is frequently the lowest-paying cash option the broker offers.

How it goes wrong

A money-market fund is not insured by the FDIC or anyone else. 'Breaking the buck' — a stable-NAV fund's share price falling below $1.00 — is not theoretical: it happened to the Reserve Primary Fund in September 2008 after it held Lehman Brothers commercial paper that lost value overnight.

Prime funds carry short-term corporate and bank credit risk that stays invisible until a funding market seizes up, as it did in March 2020, prompting the Federal Reserve to stand up an emergency liquidity facility for the money-fund sector.

Yield falls as fast as it rises; a money-market fund offers no protection against a rate-cutting cycle the way a CD locked in beforehand, or a longer bond, would.

Because the names are nearly identical, investors regularly confuse an insured money-market deposit account with an uninsured money-market fund, sometimes discovering the difference only under stress. And the quietest loss in the category is simple neglect — cash left sitting in a low-yielding default sweep, or a fund whose expense ratio, absent a waiver, has quietly eaten most of the payout.