A penny saved is 1/50th penny per year earned: our money market account

From the first page of Google Image search results and makingmoneygetretire.com

Why we have it

We have a money market account because we need a liquid (can be converted to cash quickly, as opposed to, say, our house or 30 sandwiches) place to store a chunk of money in case of emergencies and to pay one-off or unforeseen expenses. A money market account is preferable to a checking account for this because it pays us some interest. However, it does have some restrictions for moving money around, so you can't use it quite like a checking account.

Our money market account is not a path to retirement. It serves a specific purpose for a specific amount of money. A surprising number of pictures on the first page of the Google Image search results portray a savings account as a place where money grows, represented by bounding bar graphs and sprouting seedlings. Closer to reality is the humble piggy bank.

Because money market account interest rates are currently lower than inflation, all of our money in savings is slowly decreasing in value (albeit more slowly than checking), despite the accumulating interest. In headier times, interest rates may be significantly higher than inflation, but the ceiling on these returns is still very modest. Further, the modest income we get from that interest is taxed as income, just like our paychecks. For example, if we earn $500 in interest this year from our savings account, we would only net closer to $400, after taxes.  In short, these savings are not investments, and you really don't want to keep too much in this account.

The taxes paid on childrens' savings interest work differently, so we'll have to learn whether we want to do this or try our hands at something else for our future dependents. We want to be good custodians of our childrens' money. Put a pin in that.

What we're looking for

The primary attribute I look for in a money market account is the interest rate. There should be no fees, and it doesn't matter whether we ever set foot in the bank.

Federal law limits us from transferring money more than 6 times per month. There's no difference between money market accounts in that respect, but it means we can't just use our money market account for everything, skipping checking entirely.

Interest rate

Interest rate is usually expressed as an Annual Percentage Rate (APR) or Annual Percentage Yield (APY), which mean the same thing (read the fine print to confirm): the expected return over the course of a year. For example, if there is a 2% APR and you invest $100 at the beginning of the year, you will have $102 at the end of the year.

In general, online-only banks can offer higher rates of return than brick-and-mortar banks because they don't have the overhead of paying to run branches. That's good.

Having your checking and money market accounts with different banks means that it will take an additional few business days for the money to become available when transferring in or out of checking. That's bad, but not a big deal.

What we use

Capital One (formerly ING) is the savings account I have had for many years.

When I opened it, the interest rate was over 4%, but it is currently only 2%. This is influenced by a lot of factors in the economy and isn't that far out of line with most online banks right now. Because our money market account is only connected to our checking account and one investment account, it wouldn't be that much trouble to switch, if we can get a significantly better rate elsewhere.

How we use it

Money goes in

We have a scheduled transfer once a month from our checking account. This amount is roughly equal to our monthly income less our monthly expenses, pruning our checking account back to what we need to pay those monthly expenses. And whenever we have an unexpected windfall, like a bonus or a gift, I also transfer that to the money market account, immediately.

Not every month is the same, so if we end up with slightly more than we need in checking, that gets transferred to our money market account to prune checking. (The opposite is also true.) It may not be enough to warrant changing how much we invest that month, but it at least puts the money in a more productive place than checking, while we figure that out.

Money goes out

We have scheduled monthly transfers from money market to investment accounts. (These will be covered later.)

Also, when there is a large expense, like work on the house, we transfer from the money market back to our checking account to pay for it.

Parameters

The money in our money market account serves two main purposes.

Emergency fund

The primary balance of money in our money market account is our family emergency fund, if we encounter an unexpected expense or situation, like losing a job. If we didn't have this in our money market account, we would have to rely on selling investments to pay for the unexpected, which would have negative tax consequences.

The rule of thumb for emergency funds is 3-6 months of expenses, but that can vary depending on the family situation. If you own a house or have other debt payments that would be very problematic on which to miss payments, you may need more. If you live near family and/or your family is fabulously wealthy and would be happy to step in and help, you may need less.

We have an emergency fund target I will not print here that is the default value I am looking for in our money market account.

Saving for large expenses

The other reason to keep money in savings is to set it aside for foreseeable large, one-off expenses. This can be achieved by decreasing the amount of our scheduled monthly transfers from money market into our investment accounts, starting in advance of when we will need the extra money.

For example, we let our money market account balance run well over the emergency fund target amount prior to moving, prior to our wedding, and when we have had other expenses, like work on the house.

Next, I will talk about what we did once we had more than adequate money in our money market account. (Hint: dune buggies.)

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