Money market funds and certificates of deposit are alternatives to the traditional passbook savings account. Both should offer superior terms to a passbook account. Both are available from banks and from investment brokers, and both usually offer better rates when you invest more money in them. Other than that, however, they're completely different.
Money Market Funds
Money market funds are actually mutual funds; however, instead of buying stocks, they buy short-term securities. These accounts are generally managed to always keep the same share value -- $1 -- and to pay a variable interest rate that reflects that the fund's managers can get in the open market. Money market funds are not FDIC-insured but are usually very safe. Money market accounts, on the other hand, are issued by banks and are FDIC-insured. In either case, money market accounts are relatively liquid, although they frequently limit you to making no more than six withdrawals per month, and usually have minimum balance requirements.
Certificates of Deposit
With a certificate of deposit, you agree to leave your money in the account for a set period of time. In exchange for being guaranteed the use of your money, the bank pays you a higher rate of interest. CDs issued through banks are FDIC-insured, while those purchased through a broker may offer a higher rate of interest but could be placed with non-insured institutions. If you need to pull your money out before the term on the CD, you will probably be charged a significant penalty. While traditional CDs are very inflexible, some alternative products may offer the ability to withdraw your money without penalty or to increase your interest -- though they may offer lower returns in exchange for the flexibility.
When you have money that you need to keep in a very safe account but don't anticipate needing to access it, a CD is an excellent option. While CD returns are low, they're still higher than on more flexible accounts. For example, as of June 2013, Bankrate's average rate for a one-year CD was 0.66 percent while savings accounts averaged 0.50 percent. If a one-year CD doesn't suit your needs, they're typically available in terms ranging from one month to five years. Furthermore, you can set up a structure of CD accounts that can give you additional flexibility. For example, if you have money that you can invest for the long term but still want to have the option to access some of it periodically, you could split it into three pieces and buy three equally sized CDs -- a one-year account, a two-year account and a three-year account. As the CDs mature, you can roll them over into three three-year accounts and get the flexibility of one-year accounts with three-year rates. This structure is called laddering.
Money Market Benefits
Money market accounts and funds bring two advantages -- liquidity and safety. This makes them a good place to put money that you need to be able to access on relatively short notice. You can usually withdraw from a bank money market account in a matter of seconds if you're standing at an ATM machine, while it may take your broker a day or two to get money to you. While money market accounts are insured, funds are not, but generally enjoy a reputation of being almost as safe as CDs. Regulations passed after the 2008 liquidity crisis changed the way that money market funds are structured to make them safer.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.