How to Calculate Interest on a Money Market Account

Advertiser Disclosure |
Editorial Policy Disclosure

Knowing how to calculate money market interest helps you keep tabs on the long-term value of your account and compare it to other savings vehicles. How much interest does a money market account earn? It depends on your bank, and the APY on your account can change over time. A primary benefit of this short-term savings option is easy access to compound interest at better rates than traditional savings accounts.

Interest in a money market is typically compounded daily. How often do money markets pay interest? It depends. Many deposit earnings on a monthly basis, but quarterly deposits are possible. However, your interest is still compounding as an account credit, even before it is deposited.

Earning with compound interest means that your interest is credited to your account balance on a predetermined basis, such as daily or weekly, and then earns interest. The calculations for compound interest are easy to follow but can be time-consuming if you are trying to compare rates. For the sake of simplicity, use a financial calculator or the Interest.com savings calculator to save time.

How Money Market Accounts Work

Consider a money market account as an enhanced savings account. You can easily withdraw money from it up to six times per month without a fee. While savings accounts often feature easy withdrawals, most money markets include an optional checkbook and debit card. They also typically provide a better interest rate than a traditional savings accounts. Like both checking and savings accounts at your local bank, a bank-provided money market is FDIC-insured up to $250,000.

When you put your cash in a money market, it is held in low-risk or no-risk options such as government securities and certificates of deposit. The interest rate earned can vary. To maximize returns, most banks require depositors to leave a larger sum of money in the account. As deposits increase, to a certain level, the APY of the account can increase. For the extremely cash-heavy investor, there are even jumbo money market accounts that require a $100,000 minimum deposit.

How Compound Interest Works

Compound interest is earning interest on interest and is the best way to maximize your return on easily accessed savings. To put it simply, money market accounts usually compound daily, but pay monthly. Each day the principal in your money market account earns interest. That interest is credited to your account, even when it is not immediately deposited. As your principal continues to earn interest on a daily basis, so does each day’s interest. At the end of the month — or quarter for some money market accounts — the bank processes a deposit to the money market account for the accumulated interest — and interest on the interest.

Let’s look at a $1,000 investment in a money market account. It starts the year with a $1,000 balance. With a simple interest formula and a 1.5% APY, the account would earn $15 in interest over one year. With compound interest, the earnings equal $15.11.

When do the returns for simple versus compound interest start to measurably differ? In four months. Assuming an initial January investment of $1,000, compound interest ups the monthly earnings to $1.26 in April. In November, the earnings jump forward again to $1.27.

While an extra $0.11 over the year may not seem like a lot, picture it on a much larger investment, such as $100,000, or in a year with higher interest rates. With a $100,000 investment, compound interest earns $11.28 more in one year with a 1.5% rate. For $1,000 with a 5% rate, the difference grows to $1.27.

It’s also important to understand interest versus APY. The term annual percentage yield is used more frequently than interest rate because it expresses the actual earnings of your account, or the account yield. This is because the APY includes the effects of compounding interest. An account with an interest rate of 1.5% has an APY of 1.511%.

The same idea applies when reviewing APR versus interest rate on debts. The APR is the actual cost of the debt over the course of the year due to compounding interest. Unfortunately, this compounding is not in your favor.

How to Calculate Interest on an MMA

If you want to calculate compound interest the hard way, you need to know a few basic items about your money market account, including the principal, the interest rate expressed as a decimal, compounding periods and the time period of earnings you want to examine, such as annual earnings.

In the annual earnings equation below, “P” stands for principal; “r” is for interest rate in decimal form; “n” is the number of compounding periods (365 for most money markets); and “t” is for the time period, or one for one year.

Ending account balance = P(1+r/n)nt

The last step to calculate interest earned is a simple subtraction of your initial investment from the new ending account balance.

But what if you add a fixed monthly payment to the money market at the end of each month? Brace yourself.

Payment × {[(1 + r/n)(nt) – 1] / (r/n)}

In this formula, payment is the amount of your regular deposit. All other labels remain the same.

Feeling fatigued from the potential math? The Interest.com savings calculator, a scientific calculator or the time value of money features on a graphing calculator, can also help. Consult instructions for your specific model for the best results while keeping in mind the key components of the compounding equation.

The Final Word

Compound interest is fun to earn and a little less fun to calculate without assistance. Money market accounts provide access to the brighter side of compound interest in a low-risk way. Your money is protected when you use FDIC-insured banks. You also retain easy access to your cash if a better opportunity comes your way or you develop a long-term investment plan. To maximize your returns, research the APY on money markets at web-based banks and your local branch. Also, boost your balance as high as possible when you can earn a higher rate.

Read Previous $20 for every… Read Next Mortgage Refinancing in…