High Interest Money Market Accounts

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High interest money market accounts can be found online, but let the buyer beware!

That's because there are only two ways a money market fund can pay a substantially higher yield than its competitors.

The first is to take higher risks. It can buy up commercial paper issued by companies with lower credit ratings. Because they have lower credit ratings, they must reward the marketplace with higher interests rates than companies with higher credit ratings are charged.

You may judge this an acceptable risk. Many times the fund gets away with it. That's partly because the company, while a long term risk, is still functioning and able to pay off its short term debts.

That will often be true, especially when economic conditions are strong. However, be aware that the financial crisis and recession have of course made cash flows of businesses less reliable and predictable, and lower. And in September 2008, several money market funds broke the buck (went below $1 per share) because Lehman Brothers filed bankruptcy. They were a well respected firm, and until that turmoil, nobody realized they could go out of business so quickly.

Of course, that week in September 2008 was exceptional. There'd been nothing like it before and hopefully won't be again for a very long time. However, you should understand there's always an element of risk involved with money. Treasury bonds from the United States government are considered risk-free because the United States government will never willingly default on them, and is strong, and can in theory tax people and print money to cover the interest. However, there's some risk it could go down. I hope that's never, but it wouldn't be the first powerful government to become a piece of history.

In 2010 the Securities and Exchange Commission issued new regulations restricting how much money market fund companies can invest in higher risk ("Second Tier") investments, but it's still allowed, though to a smaller degree than before 2010.

The Second Way to High Interest Money Market Accounts

That's if the money fund company has a lower than average management expense ratio.

Many people overlook that factor, but it's important. All money market funds buy up the same kind of short term, high credit commercial paper.

Therefore, the money fund that is most efficient in running its operations takes the least money out of your account. (Since the NAV must always remain $1, they don't take it from your account balance, but do from the amount of interest they give you credit for.)

So the lower their expenses, the higher your interest rate.

Money market average expense ratios run around 0.6%. That's six-tenths of one percent. However, Vanguard's Prime Money Market's expense ratio is 0.23%. You may be able to find one lower than that, but Vanguard is the mutual fund family that generally cuts expenses as low as they can possibly go.

The expense ratio of Vanguard's Tax Exempt Money Market Fund is only 0.17%, but I'm assuming that if you want a high interest rate, you're not looking for a tax exempt fund.

Be smart when you look for high interest money market accounts, so you don't get burned if there's another financial crisis.

Next: Money Market Interest -- what can affect the rates of interest your money earns.

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