How the President-Elect Can Affect Money Market Accounts

How much you earn on a money market account comes down to a few important factors, none of which directly involve a newly elected president. Here's how it works.

The Federal Reserve

The Federal Reserve (commonly referred to as the "Fed") is the U.S. government's central bank. Its purpose is to keep the U.S. economy stable, and it has the power to set some economic policies toward that goal. Within the Fed is a group called the Federal Open Market Committee (FOMC) -- they're the decision makers. The FOMC consists of 12 members:

• Seven members of the Board of Governors of the Federal Reserve System
• The president of the Federal Reserve Bank of New York
• Four of the remaining 11 Reserve Bank presidents (serving one-year terms on a rotating basis)

While that may seem confusing, the important thing to remember is this: The Federal Reserve decides when rates need to be raised or lowered. They are not politicians, but rather, a small group made responsible for protecting the U.S. economy. Keep reading. We'll break down how it works and how decisions made by the Federal Reserve ultimately impact you.

Preventing a run on the bank

By law, banks must maintain a reserve of money equal to a percentage of their deposits. That money is kept in an on-site vault, at a larger bank, or a Federal Reserve bank facility. And there's a very good reason for this law. 

Imagine that one of your friends is leaving on vacation and stops by the bank to withdraw $1,500. The bank doesn't have enough money on hand so they tell your friend, "Sorry. We can't help you right now." Naturally, your friend is upset and goes to social media to post about what happened. Suddenly, people reading the post begin to worry about what's going on and if their money is safe. Just to be sure, they run to their banks and begin withdrawing all their money. Other people notice, and decide to withdraw their money too. The panic is contagious. It's called a "bank run" or "run on the bank." 

To prevent a run on the bank, laws were written that require banks, credit unions, and other financial institutions to keep an appropriate amount of cash available to avoid such a run on the bank.

Let's say Bank A realizes it's going to be short on cash by the end of the day. It turns to Bank B to borrow the money. Bank B makes the loan, but charges interest. The interest it can charge is set by the Federal Reserve and is called the federal funds rate. Banks cannot charge another bank any more or any less than this rate. 

What's interesting about this rate is how it trickles down to you. 

Back to what the board is up to

The board meets eight times each year. One of their tasks is deciding whether there should be any changes in the federal funds rate. 

When the economy is moving toward recession, this committee lowers the federal funds rate. That makes it cheaper for banks to borrow money, and can help get the economy moving when things are slow. When the economy is growing too quickly, the FOMC raises the federal funds rate to keep that growth under control.

A president-elect may hope the interest rate will rise or fall, but they don't have the authority to demand change. It is the Federal Reserve (commonly referred to as the "Fed") that determines rate changes. That's not to say a president-elect plays no role in setting the federal funds rate. 

The FOMC attempts to predict each new president's actions, and changes the federal funds rate accordingly. Their goal is to predict whether proposed policies are likely to lead to economic growth.

However, the potential actions of a president-elect are just one small factor in the FOMC's decision-making process. The driving influence is how a rate change will impact the economy, based on everything going on in the U.S. and internationally.

The trickle-down effect

The decisions made by the FOMC impact you when it's time to take out a loan or open a savings account. It may also impact the amount you earn on a money market account, depending on when it was opened. 

How changes in the federal funds rate can impact money market accounts

Banks use the federal funds rate as a foundation to decide rates for deposit accounts, loans, and more. When the federal funds rate goes up, banks' rates go up, too: Savings accounts earn more interest, and loans charge more interest. When the federal funds rate goes down, banks' rates go down.

One attractive feature of a money market account is that you lock in the interest rate when you open an account. So even if the Fed drops its rate and the prime rate follows, you get the same earnings for the entire term.

How are money market account interest rates determined?

When your bank decides on interest rates for money market accounts (or other interest-bearing products), they decide how much over the federal funds rate they are willing to pay depositors. Let's imagine that the federal funds rate is 0.25%. If your bank offers 0.50% interest on a money market account, that means you're receiving 0.25% over the federal funds rate.

The interest rates quoted on money market accounts vary by financial institution because each sets its own rate based on the federal funds rate.

What to consider if you're looking for a money market account

If you want to open a money market account, there are a few factors you should pay attention to. These include:

• APY: This determines how much money you earn from your money market account. Look for the highest rate you can find.
• Access to your money: Every money market account is different. Some offer easier access to funds than others. Find out if an account allows you to transfer money online, and whether you can withdraw funds from an ATM. If you plan to use your money market account as an emergency savings account, it is essential to have access 24/7. While you're at it, make sure the bank allows you a large enough daily ATM withdrawal limit to cover most emergencies.
• Account limits: All money market accounts are subject to federal transaction limits, no matter which financial institution you bank with. Once you've passed the transaction threshold, you will be charged a fee. It's helpful to fully understand how many transactions are available to you. For example, you may be able to withdraw funds from an ATM or bank teller if you have a limit on the number of checks you can write per month.

The bottom line

Money market accounts can be an attractive place to keep money. They typically offer higher-than-savings interest rates, check-writing and debit-card privileges, and FDIC insurance. They are not for everybody, though. Here are two issues that may be considered drawbacks:

• High minimum deposit: Typically, money market accounts require a higher minimum balance than savings accounts. The highest interest rates are paid on accounts with large deposits, often in the four- or five-figure range.
• Higher rates may be available: Regardless of what the Fed does next, you may be able to earn a larger return with a certificate of deposit or high-yield savings account. It pays to check all your options.

Ultimately, the Federal Reserve's rate decisions determine whether you can afford to buy a home, use credit cards, or take out a personal loan to remodel the kitchen. It's also the Fed's rate that sets the foundation for how much you earn on deposits, including money market accounts.

If you want to know what's likely to happen to interest rates in the near future, it's as easy as paying attention to what the Fed does next.