Even though high-yield online savings accounts are currently wiping the floor with high yield money market mutual funds yield-wise (Ally Bank and HSBC Direct both have great rates, currently), the high yield money market mutual fund vs high yield savings account debate is far from over.  For example, the Vanguard Prime Money Market Fund (VMMXX ) currently yields a paltry 0.23% while the average online savings account yields around 1.5-1.7% (as of 8/12/2009).  While the supply/demand situation is currently heavily in favor of online savings accounts due to the banks need to attract deposits in a hurry, I have little doubt money market mutual funds will again have their day in the sun.

How Money Market Mutual Funds Differ From Savings Accounts

Money Market Funds are complex beasts compared to savings accounts and differ in several key ways.  By keeping the following differences in mind, youll be better able to make an informed choice.

• Not FDIC Insured Perhaps the biggest difference between traditional savings accounts and money market mutual funds is that they arent FDIC Insured.  This makes money market funds ever-so-slightly more risky than savings accounts; however, not once in our nations history has an investor lost so much as a cent in a money market fund.  So while they are technically more risky, the difference is probably not big enough to bother with.  The higher-quality money market funds, such as Vanguard Prime, hold as much as 40% of their assets in short-term U.S. Treasury Bills, the safest investment on the planet.
• They Arent Tied To A Bank When you open a high-yield savings account with Ally Bank. your money is held on deposit at that bank.  By contrast, when you invest in a money market mutual fund your money is pooled with thousands of other investors to purchase short-term cash-like assets such as Certificates of Deposit. Treasury Bills, and commercial paper.  That is, your money isnt is spread out over many different banks, not just one.  Therefore, you generally cant just go to a bank teller and ask for your money back:  you have to initiate an electronic funds transfer from your mutual fund company .
• They Come In Tax-Free Varieties Unlike savings accounts, whose earnings are always taxable as regular income, there exist tax-free money market funds.  The yields are generally lower than their taxable cousins, however, and only investors in the higher tax brackets will likely benefit.  If you are in the 25% tax bracket or above, you should do the math to find out if you would come out ahead buying a tax-exempt fund.  Generally those in the 25% bracket are right on the cusp, but those in the 28% or above bracket are practically always better off with a tax-free fund.

How To Pick A Money Market Mutual Fund

There are really only three things you need to consider when choosing a money market fund.

Expense Ratio