How are money market interest rates determined?

A money market account can provide a safe place to set aside liquid funds that you may need to access in the event of a financial emergency. You can also use this type of account to hold funds during times of market volatility. No matter why you keep cash in a money market account or money market mutual fund, it is important to understand how the interest rate paid to the account is determined.

You can set aside funds in a money market account held with a bank or credit union, known as a money market deposit account. Although some may compare this to a conventional savings account, a money market deposit account varies in that the financial institution has fewer restrictions on how your deposited funds can be invested.

In a savings account, the bank or credit union is only able to lend those funds out to other customers and charge an interest rate on the loans. With a money market deposit account, banks can invest deposited funds in short-term securities, including certificates of deposit (CDs), municipal bonds and treasury notes (T-notes). Additionally, they may also loan out funds to other customers. This sometimes provides investors with higher interest rates than traditional savings accounts.

Similar to a money market deposit account, a money market mutual fund provides a relatively low-risk setting for cash-equivalent liquid funds. Money market mutual funds invest in the same short-term securities as banks offering deposit accounts, which may include commercial paper, treasury securities, municipal bonds and other highly-rated debt securities with a maturity date of less than one year.

Although the interest rate paid to a money market account may not be high relative to other investment options, both money market deposit accounts and money market mutual funds may provide more interest than a conventional savings account due to the underlying securities managed by the bank or mutual fund company.