High-Yield Savings vs. Money Market Funds: A Quick Comparison

High-Yield Savings vs. Money Market Funds: A Quick Comparison

When helping clients optimize their cash, two leading options are high-yield savings accounts and money market funds (MMFs). While both are excellent for short-term savings and liquidity, the way they work, their risks, and their protections differ in important ways.

How High-Yield Savings Accounts Work

High-yield savings accounts are bank deposit accounts that pay interest rates far above the national average. Interest is compounded, usually daily, and credited monthly. These accounts are ideal for emergency funds and short-term savings goals, and they are insured by the FDIC up to $250,000 per depositor, per bank, per ownership category. That means your money is protected by the federal government if the bank fails, with no risk to your principal as long as you stay within insurance limits.

How Money Market Funds Work

Money market funds, by contrast, are investment funds, not bank accounts, that invest in short-term, high-quality debt securities such as Treasuries and commercial paper. When you invest in a money market fund, you’re buying shares of a pool of assets, and the fund’s yield closely tracks current short-term interest rates. Yields on MMFs can adjust rapidly as rates change, and the rate you earn is not set by a bank but is determined by the underlying market. While MMFs are not FDIC insured, they are regulated to minimize risk and are considered extremely safe, though not entirely risk-free.

Yield Differences

When comparing yields, money market funds often pay slightly more than high-yield savings accounts. For example, if you and your spouse have $500,000 in a high-yield savings account and are earning 0.20% less than you could in a comparable money market fund, that’s a difference of $1,000 per year in potential earnings.

Tax Considerations

Tax treatment is another important factor. Interest from high-yield savings accounts is fully taxable at the federal, state, and (for higher earners) Net Investment Income Tax levels. Money market funds are similar by default, but they offer more flexibility. General taxable MMFs are taxed just like savings accounts, but government or Treasury MMFs can reduce or eliminate state income taxes because much of their income comes from U.S. Treasuries. State-specific municipal MMFs may even avoid federal, state, and NIIT taxes altogether, though these often have lower stated yields. When comparing options, it’s important to look at after-tax yields, not just the headline rates.

Insurance and Risk

In terms of risk, high-yield savings accounts offer unmatched safety: FDIC insurance guarantees your principal up to $250,000 per depositor, per bank, per ownership category. Your account value does not fluctuate, and you are not exposed to losses from the bank’s loans or investments, provided you remain within the insurance limits. Money market funds, while not FDIC insured, operate under strict regulations that make losses extremely rare. The most well-known exception is the Reserve Primary Fund, which “broke the buck” during the 2008 financial crisis after holding significant Lehman Brothers debt. Investors lost about 3% of their principal in the short term, but most ultimately recovered much of it. This event led to stricter regulations and greater fund resiliency.

Key Takeaways

If you are extremely risk-averse, a high-yield savings account offers the unmatched protection of FDIC insurance. However, history shows that money market funds “breaking the buck” is extremely rare, and investing in a money market fund can increase your returns on cash, especially over the long run. The right choice depends on your risk tolerance, liquidity needs, and tax situation.