Highest Money Market Rates

When people express their longing for the highest money market rates, it’s hard to tell if they are talking about APY (annual percentage yield) of money market funds, or about APY of money market accounts. These two investment channels — money market funds (MMFs) and money market accounts (MMAs) — both depend on the outcome of transactions taking place in the money market, but they are entirely different things.

To understand the differences between the two, and to have an idea as to which of them is referred to in the investing public’s desire for highest money market rates, it’s good to review money market fundamentals.

In the broadest arena there’s the financial market, the economic mechanism which brings people together so that they can trade —buy and sell — in what they call “commodities” and “financial securities”. Commodities are precious goods from gold and silver to wheat and dairy, while financial securities consist of things you often hear from business news on TV: stocks and bonds.

The financial market has component markets: stock market, bonds market, commodities market, and money market.

In the money market, the assets that are traded are papers that evidence indebtedness of large corporations. An illustration follows.

John borrows $1,000 from Peter and writes down on a piece of paper, “IOU $1,000 payable in 6 months with 2% interest”. That paper is evidence of John’s indebtedness to Peter. If Peter wants to make early money out of John’s IOU, he can go to the money market and sell the IOU at a discount in order to attract a buyer. When sold to Paul at a selling price of $950, the discount is 5%. After 6 months Paul sells the IOU to Matthew for $980, and makes $30 from the sale. Finally, Matthew collects the $1,000 face value plus interest from John and makes a profit of $20 plus the interest on the IOU.

The money market works somewhat that way but in a much more complex setting and a staggering volume of transactions. Combined earnings of all money market transactions are expressed in APY. If on a certain trading day IOUs earned 2% APY, treasury bills earned 1.2%, and certificates of deposit earned 1.35%, the winner of the highest money market rates award (so to speak) is IOUs.

The money poured into this market comes from wholesale MMFs pooled from numerous retail investors and entrusted to the custody of big-time institutional financial players that participate in the money market. Having no direct access to MMFs, individual investors deal with a professional fund manager. The fund manager, in turn, deals with brokers.

The fund manager tries to secure for his clients the highest money market rates possible in his portfolio.

Individual investors can also access the money market indirectly through the MMA service sold by banks. Since banks have more conservative portfolios than independent professional fund managers, the highest money market rates on MMAs are often less than those of MMFs.