How to Calculate Interest on a Money Market Account
Point of Interest
A money market account compounds your interest daily, meaning you earn interest on your interest, so it’s important to know how to calculate daily compounding interest on your money market account.
Learning how to calculate interest on a money market account can seem intimidating. A money market calculator can help, but it’s especially useful if you understand the theory and formula behind compound interest. Plus, it’s useful to know that interest is compounded daily on a money market account (MMA), and understand why that matters.
By learning how to calculate interest on money market accounts or money market funds, you can better understand how compound interest can earn you money.
Tip: When you’re comparing money market accounts, look at the annual percentage yield (APY) rather than the interest rate. The APY includes the effects of compounded interest, so it’s the most accurate number you can use.
How money market accounts work
A money market account is a fusion between a checking account and a savings account. Like a traditional savings account, a money market account pays you interest to deposit your money into the account. With a money market account, you’ll earn interest — and sometimes at a higher rate — but you also get a debit card and checks so you can easily access your funds. The investment is low risk, unlike investing in the stock market.
Both a traditional savings account and a money market account have restrictions for the number of withdrawals you can make per month. However, a standard savings account doesn’t offer you a debit card or checks. If that’s useful to you, consider a money market account instead.
Another option for earning interest while stashing your cash is a certificate of deposit (CD) account. You won’t get a debit card or checks with a CD, and you’ll have to leave your money alone for a specified term if you want to avoid paying penalties. You don’t have to do this with a money market account. With an MMA, you can also add money to the account at any time, but that’s not the case with a CD. The money you initially deposit is the money that earns interest for the life of the CD.
Tip: A money market account is best for someone who doesn’t need to sock away their savings. Easier access to your money through the money market’s debit card and checks could mean spending more than you’re saving.
How compound interest works
Interest is the money you’re paid by the banking institution for leaving your money in your account. Simple interest accounts only offer interest on the amount of money you deposit, not on any interest you earn. On the other hand, compound interest accumulates on the principal — or the initial amount you deposit — as well as on any interest you’ve made. Thus, if you make $5 in interest one year, the next year, you’ll receive interest on that $5 — along with the interest on the principal. This additional amount can add up over time.
The current average interest rate for money market accounts isn’t much higher than a standard savings account: 0.09% vs. 0.06%. However, you can expect these numbers to fluctuate as interest rates fluctuate, and some banks offer a much higher rate than the average. For example, CIT Bank‘s money market account compounds daily and has a 1.20% APY, which is fantastic. Another online bank, Quontic Bank, has a money market account offering an even higher APY of 1.30%. Given how APYs vary, it’s worth shopping around to find the best choice for you.
Tip: Compound interest is best for accounts with high balances, like accounts that contain over $100,000. But even if you don’t have that amount in your account, compound interest can still give you more bang for your buck than simple interest.
How to calculate compound interest
Figuring out how much money you’ll make with compound interest seems challenging, but it’s easy enough when you use an online money market interest calculator. To calculate compound interest, you’ll need:
- Principal (P) — How much money you initially deposit into the account
- Interest rate (r) — What percentage you’re earning interest at
- Compounding periods (n) — How many times interest is calculated per year
- Time (Y) — How long you agree to leave your money deposited in the account
In this equation, you are trying to find the future value (FV). You’ll plug your information into this formula to determine how much interest your money will earn in the money market account.
FV = P (1 + r / n)Yn
For this example, let’s say you invest $1,000 in a money market account and let it sit for 10 years. The equation starts to come together:
FV = 1000 (1 + r / n)10n
Let’s then say you get an interest rate of 8%, written as 0.08. Interest for money market accounts accumulates daily, so there are 365 compounding periods for the account.
FV = 1000 (1 + .08 / 365)10×365
This formula simplifies down into:
FV = 1000 (1 + .08 / 365)3650
In this scenario, FV equals $2,225.35. Thus, after 10 years, you will make $105 in interest without touching your money. If you do the same calculation with annually compounding interest, you will only make $2,158.92. Thus, you’ll get almost $67 more with daily compounding interest.
This might not sound like a lot after 10 years, but it’s especially useful for high account balances. An account with over $100,000 deposited into it is called a jumbo money market account. If we use an example of an account balance of $100,000 left alone for 10 years with the same 8% interest rate, without daily compounding interest, you would have around $215,892, so more than double your initial deposit. With interest that compounds every day, you would have about $222,534. So you would earn $6,642 more just by having an interest that compounds daily.
The final word
Learning how to calculate interest on a money market account can seem difficult, but using a money market interest calculator simplifies things immensely, as long as you know the four things you need to plug into the formula. Take a minute to figure out the difference that daily compounding interest can make to your money market account. The final number may surprise you.