What it means
The bank pools the deposits from many customers and invests them in short-term, low-risk instruments, then passes on part of the return as interest. Accounts typically offer variable rates that follow wider interest rates, and the rate may rise with higher balances.
Customers can usually make payments by cheque or debit card, though the number of withdrawals may be limited. Because it is a deposit with a regulated bank, the money is generally protected by deposit insurance up to a legal limit per depositor, per institution and per ownership category.
Limits and conditions differ by country and are updated from time to time. This protection is a key difference from a money market fund.
A money market fund is an investment product sold by asset managers, which holds short-term securities and is not a deposit, even though it aims to keep the value of each unit stable. Deposit insurance does not usually cover it.
The names are similar and are easy to confuse, so it pays to check which product is being offered. Businesses use money market accounts to hold cash reserves, such as tax payments set aside for later in the year or an emergency buffer.
The account earns more than a current account while keeping funds available. Treasury teams compare the rate with other options, taking into account minimum balances, fees and withdrawal limits.
The quoted rate is not the whole story. Interest may compound daily, monthly or quarterly, so the annual percentage yield (APY), which includes the effect of compounding, is the right figure for comparison.
Teasers that expire, balance tiers and monthly maintenance fees can reduce the effective return.
In practice
Real-world examples
Example 1
A small design studio sets aside $40,000 for its quarterly tax payments and keeps it in a money market account. The money earns interest until the due date and is available by transfer when needed. The finance manager schedules the withdrawals to stay within the account's limit.
Example 2
A family business holds six months of operating costs, $120,000, as a cash reserve. The treasurer chooses an insured money market account over a current account paying no interest. She spreads the money across two banks to remain within deposit insurance limits.
Example 3
A charity receives a large donation for a project that starts in nine months. The finance team places it in a money market account so that it earns a modest return and remains safe. It compares the rate with a fixed-term deposit before deciding.
Think of it
Think of a money market account as a secure parking garage for your car. You can drive out whenever you need to, but while your car is parked there, the garage management pays you a small bonus just for leaving it in their care.
Formula
Calculation
Annual percentage yield = (1 + r / n)^n - 1
Interest earned = Balance x APY (over one year with no withdrawals)
Suppose a business keeps $50,000 in an account that pays 4.0% a year, compounded quarterly, so r = 0.04 and n = 4. The quarterly rate = 0.04 / 4 = 0.01, so APY = (1.01)^4 - 1 = 1.04060401 - 1 = 0.0406, or 4.06%. Interest earned over a year = 50,000 x 0.04060401 = $2,030.20. A flat 4.0% with no compounding would give 50,000 x 0.04 = $2,000, which is $30.20 lower.Case study
Seen in the real world
Birchwood Consulting is an illustrative, fictional firm with $250,000 of surplus cash that was sitting in a current account earning nothing. The finance manager compared three options: a money market account at 3.8% APY, a one-year fixed deposit at 4.1% and a money market fund at 4.2% with no deposit insurance.
On $250,000, the money market account would earn 250,000 x 0.038 = $9,500, the fixed deposit $10,250 and the fund $10,500. The fixed deposit would lock the money away for a year, and the fund carried a small risk that its value could dip.
The firm placed $150,000 in the money market account for flexibility and $100,000 in the fixed deposit. The illustrative lesson is that the highest advertised rate is not always the best choice once access, safety and the reason for holding the cash are taken into account.
Watch out
Common mistakes
- Confusing a money market account with a money market fund, when only the account is a deposit that benefits from deposit insurance.
- Comparing quoted rates instead of annual percentage yields, which ignores differences in compounding.
- Overlooking minimum balances, withdrawal limits and fees, which can cancel out the higher interest.
Questions
People also ask
Is the interest rate fixed?
Usually not, because most money market accounts pay a variable rate that moves with market interest rates, and the bank can change it.
Is the money safe?
Deposits at regulated banks are normally covered by deposit insurance up to a legal limit, so amounts above the limit should be spread across institutions.
How is a money market account different from a savings account?
It usually pays a higher rate on larger balances and offers limited payment features, though it may require a higher minimum balance.