Money Market Account

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A money market account comes in several varieties.

Money funds are regulated by the Investment Company Act of 1940, rule 2a-7 restricting the quality, maturity and diversity of investments.

They are required by the Securities and Exchange Commission to keep a varied portfolio with a weighted average maturity of no more than sixty days (used to be 90 days). They are allowed to have securities with maturities of more than sixty days (but individual securities can have a maturity of up to 120 (used to be 397) days so long as the weighted average remains below 60%).

A Money Market Account Must Be Kept Liquid

They cannot tie up more than 5% (used to be 10%) of the fund's assets in illiquid securities. "Illiquid" means any security that cannot be sold or redeemed into cash within seven days.

First of all, some money market accounts are taxable and some are nontaxable.

Taxable money market funds are divided into general, U.S. government and Treasury-only.

Nontaxable money funds are divided into national and state-specific funds.

Taxable general funds are the most common and the most popular. They may invest in a wide variety of short term securities: T-Bills, commercial paper, bankers acceptances, certificates of deposit, repurchase agreements and even off-shore securities.

Taxable funds are required to keep at least 10% (on a weekly basis) or 30% (on a weekly basis) of their funds in cash or US Treasury securities to keep them liquid enough to handle requested refunds.

There are restrictions on how much they can invest in "Second Tier" (lower quality) investments. They cannot now invest more than 3% (used to be 5%) of the fund's asset into Second Tier securities. They also may not invest more than one half of one percent of assets into Second Tier securities (used to be one percent or one million dollars). They also may not buy Second Tier securities that have a maturity of over 45 ddays (formerly 397 days).

The changes were enacted in 2010 as a result of the problems that arose with several money market funds in the financial crisis of September 2008. They broke the buck because they owned securities issued by Lehman Brothers, which went broke very suddenly. I doubt Lehman Brothers was considered a Second Tier security before the crisis.

Now a Money Market Account is Even Less Risky Than Before

U.S. government taxable money market accounts invest in any short term security issued by an agency of the U.S. government. In times past it was assumed these agencies did not enjoy the 100% guarantee that the Treasury securities did. However, in the financial crisis the U.S. Congress decided to protect Fannie Mae and Freddie Mac even though it had no legal, explicit obligation to do so.

Some money market funds invest only in obligations issued by the United States Treasury. These are considered 100% safe. When the United States government cannot pay the interest on its debt, the world will be suffering from a great catastrophe and you'll be more worried about survival than your investment portfolio.

Nontaxable money market funds invest in short term securities issued by local and state governments. By law, the interest they pay is not subject to federal income taxes.

General nontaxable money market funds buy the securities of local and state governments around the United States, and are suitable for people who live anywhere in the United States.

Some nontaxable money market funds are state-specific. To encourage their residents to buy municipal bonds within their states, some states do not tax the interest returned on those bonds. Therefore, some financial institutions have funds that buy only the securities issured within that state. Residents of that state can save on taxes by using a money market fund dedicated to that state. This is especially helpful for high-income residents of high tax states such as New York and California.

No matter which type of money market account is right for you, they are very useful personal financial tools.

Next: Money Market Account Rates -- how to evaluate relative money market interest rates

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