In a traditional savings account, banks take your deposits and loan them out. A bank is able to loan out much more than it has in reserves. This is because the Federal Reserve sets the amount of reserves a bank must keep on hand, which is usually between 3 and 10 percent of its deposits.
So, for every $100 you deposit, the bank can loan out between $90 and $97. Those loaned out dollars generally wind up in other accounts, and get loaned out again, creating much more economic activity than you might expect.
Banks loan money out at higher interest rates than those they pay depositors, and make their profit by keeping the difference. Banks also generate profits through fees such as ATM fees, overdraft fees, account fees, etc. To meet reserve requirements, banks frequently make short-term loans to one another.
Money Market Accounts
Money market accounts are a little bit different. They’re designed to compete with and mimic money market funds offered by brokerage firms. The money you deposit is invested in specific, short-term government and corporate securities in the money markets. These investments include Treasury bills, bankers’ acceptances, and certificates of deposit, among other lending instruments. The bulk of the money market involves banks lending to one another.
Money Market vs Savings Accounts
Money market and savings accounts have a lot in common:
- FDIC-insured: They are both FDIC-insured up to the limits as long as the account is with member FDIC financial institution.
- Interest bearing: They both pay interest on the deposited balance.
- Withdrawal limitations: For both accounts, there are federal limits on the number of withdrawals you can make each month (typically six). Generally, banks enforce this rule by charging heavy fees for withdrawals and transfers after number six.
- Simple to open and manage: Both account types can be opened online or at a branch. In our experience, online banks pay higher rates and charge lower fees.
Here’s a look at the differences between the two accounts for the account holder:
- Interest rates: The interest rates can vary on the two accounts. Historically, money market accounts have paid higher rates, and that may still be true at traditional banks. With online banks, however, savings account rates are very competitive.
- Account management: Perhaps the biggest difference is how you manage the account. With a money market account, you can spend finds with checks or an ATM card. With a savings account, withdrawals typically are limited to in-person or online transfers.
If you’re looking for a place to earn interest on your extra cash, a money market account is probably the place to stash it. Shop around for an account with a competitive interest rate and suitable account minimums. Make sure you understand the fee schedule. The last thing you want to do is run into hefty fees because of one too many transactions.