If you want to diversify your investment portfolio, two of your safer options include money market accounts and certificates of deposit. Both of these financial instruments offer FDIC insurance, meaning that your principle and any interest earned are insured by the federal government up to the limit of $250,000 per depositor as of 2010. These accounts also have significant differences, which can affect the money you earn as well as your ability to access it.
Money Market Funds
Before investigating money markets, its important to distinguish between money market accounts and money market funds. Money market accounts are essentially a savings vehicle and a relatively risk-free way to set aside money. Money market funds are uninsured investment vehicles, meaning that you put both your principle and your interest earned at risk. However, money market funds are not high-risk as their value depends on short-term, relatively liquid securities.
Money market accounts, or MMAs, and certificates of deposit, or CDs, have distinct types of restrictions. Money market accounts have liquidity, meaning you can open and close them for any term. You can also deposit to and withdraw from the account, as long as you maintain minimum balance requirements and do not exceed six transactions per month. Traditional CDs typically have more restrictions. You open the account with a specific balance and for a specific time frame, usually ranging from three months to five years, and cannot deposit to or withdraw from the account. You also cannot close the account until the end of the term without incurring a financial penalty.
In most cases, the tighter restrictions on CDs mean greater earning potential for you. An MMA, even one requiring a higher minimum balance, typically does not offer the same interest rate as a CD. While some online MMAs may have higher interest rates that make them a viable option when comparing your earnings, the same holds true for some online banks' CDs, especially those with longer terms or requiring a higher minimum balance.
Both CDs and MMAs form the conservative segment of an investment portfolio. Their differences, however, are essential. In an uncertain interest rate environment, opting for an MMA means that your interest fluctuates daily. Investing in a CD locks you into an interest rate for the term of the investment. If you predict interest rates will plunge, locking into a rate may benefit you. However, if you think they may rise, you might prefer the liquidity of an MMA. Some investors hedge their bets by investing in several CDs at tiered time frames so that they have accounts consistently maturing.
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