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You can get Risks of Money Market Accounts

Start with the riskiest kind of investment: stocks. With a stock, you are literally buying a small piece of a company. The price of that company’s stock is usually tied to its earnings growth. However, there are many other factors affecting a stock’s price that have nothing to do with the company itself. Outside risks could be generated from the economy, from economic policy, from fiscal policy, from unforeseen events, from…just about anything. Investors, however, are usually rewarded for taking this risk. They could lose all their money, but in exchange could also multiply their investment several-fold.

Bonds allow an investor to loan money to a company. All the same risks apply to bonds that they do to stocks, but with a few differences. A company must pay its obligations to bondholders before any other investors. If the company goes bankrupt, bondholders are first in line to take control of any remaining assets. This all translates to less risk, and therefore less return. Corporate bonds may return anywhere from 3% to 10%, depending on the financial health of the company.

Government bonds are next on the scale of risk. Because the federal government is highly unlikely to default on any payment to its lenders (such as investors who purchase government bonds, known as Treasuries), there is virtually no risk attached to these bonds. The longer the maturity of the bond, the higher the interest rate. This is because an investor should be rewarded for tying up his money for a longer time, and because there is a theoretical risk that the longer the loan, the greater the possibility of default. 30-year government bonds yield 3.35% right now, while 5-year bonds yield 0.95%, and 1 year bond yield a tiny 0.08%.

Certificates of deposit are vehicles where an investor loans a bank money. It’s a bit like investing in a bank bond. The bank gets to keep the money for a set period of time and, like a government bond, the longer the period, the higher the yield. However, because these loans are guaranteed by the FDIC, the investor is taking on negligible risk. Therefore, he’ll get negligible return. Yield is really just tied to maturity. You may find that a higher investment also yields a higher return. To compare to government bonds, a 5-year large-balance CD pays around 2.2%, whereas a 1 year CD pays about 1.2%.

Bank checking and savings accounts are at the bottom of the risk scale. They are FDIC insured, and yield about the same as a 1 year government bond.

What is a money market account? Money market accounts are a happy medium for many investors. Because they are FDIC insured, they offer virtually no risk whatsoever. Nevertheless, they offer competitive yields. A large-balance money market account yields around 1% annually, the same as a five-year government bond! In addition, whereas CDs require you to tie up your money for a year, a money market account gives you total access to your money for just a tiny fraction less on the yield.