A money market fund and a certificate of deposit are both investment vehicles, meaning that you put your money into them with the expectation of getting more money out. It is not cut-and-dry whether investors get a larger return on their investment in a money market fund or a certificate of deposit, also called a CD. They are two different vehicles with different rules for you to consider.
Money Market Funds
A money market fund is a type of mutual fund that invests your money in low-risk securities, such as Treasury bills, government bonds, corporate bonds or short-term CDs. These funds pay dividends similar to short-term interest rates. Money market funds are liquid, meaning you can write checks against your fund’s balance if you need to.
Certificates of Deposit
A CD is a savings account that you set up with your financial institution. CDs offer higher interest rates than regular savings accounts do. When you buy a CD, you must choose how long you're going to keep you money in it without touching it. Typical lengths of time are six months, one year or five years. Typically, the longer you can keep your money tied up in the CD, the more interest you can earn. You cash in your CD when it matures, and you get your original investment plus the accrued interest.
Considerations for Money Market Funds
Even though you can invest in money market funds at a bank, the Federal Deposit Insurance Corp. does not insure them as it does CDs. Money market funds are highly regulated under the Investment Company Act of 1940, and they aim to keep a fixed price of $1 a share, even if the investments are doing poorly. Although it's rare, it is possible to lose money in a money market fund. For example, Lehman Brothers bonds, held by the Reserve Fund, fell below $1 in September 2008.
Read the prospectus to obtain information about the money market fund before investing in one. Also, keep in mind that funds charge fees to pay the person who oversees the funds. You want to go with a mutual fund with the lowest fees, because fees reduce the amount you can earn -- your yield.
Considerations for Certificates of Deposit
The FDIC insures the money you put into CDs up to $250,000, but only if you buy your CD at an insured institution. If you buy from an uninsured company, your money could be at risk. If you find a CD that advertises a rate that is much higher than what the banks are paying, that could be a sign that the company is not federally insured. Find out before investing your money. Also, only invest in a CD if you're sure you can leave the money there until the CD matures. Otherwise, you pay a fine for early withdrawal.
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