How Does a Money Market Account Work?

How Does a Money Market Account Work?

A money market account is also known as a Money Market Deposit Account, or a Money Market Demand Account (MMDA). These offer the depositor a reasonably high rate of return at low levels of risk. Here's more...
Money market accounts offer competitive rates of interest on reasonably large deposits, thus providing the depositor the benefit of high returns. They can be opened at banks and credit unions. Credit unions are cooperative financial non-profit institutions. Both banks and credit unions provide loans and accept deposits. However, bankers are motivated by profit, and hence, charge a higher rate of interest on the loans. Credit unions, on the other hand, charge a low rate of interest, and any interest earned is either plowed back or distributed among the members (account holders) of the credit union as dividend. Moreover, banks pay federal and state taxes, while credit unions are exempt from taxes. The members of the credit union generally share a common agenda.

Working of a Money Market Account

Interest: These accounts are meant for people who can deposit a reasonably large amount of money in the bank or in a credit union. In return, banks and credit unions pay a generous interest rate on the deposits. The rate of interest is known as the Annual Percentage Yield (APY) and is calculated using the following formula: APY = (1+i/n)^n-1. Here 'i' is the annual interest rate and 'n' is the number of compounding periods in a year. The interest is compounded daily, and hence, is significantly high.

Creation: As mentioned previously, MMDA are meant for people who have enough liquidity. The minimum amount of money required to open a money market account varies between $1000 and $2500. Moreover, a person needs to maintain a minimum balance of at least $500 in order to earn interest on the deposit. In case the balance falls below the required minimum, the account holder is penalized.

Withdrawals: People are allowed to withdraw money from their account using a check. However, this facility can be accessed about 3 to 5 times a month. The minimum amount of withdrawal is also specified. The minimum amount that can be withdrawn varies between $100 and $500, and sometimes there are withdrawal fees.

Closing a MMDA: A money market account can be closed anytime without incurring any penalty.

Advantages

Money is Insured: The money deposited in the account is insured. This means that, even if the bank or the credit union goes out of business, the depositor is in no risk of losing his money. In case of banks, the Federal Deposit Insurance Corporation (FDIC) insures up to $250,000 deposited by a person in a money market account. In case of accounts offered by credit unions, the National Credit Union Administration (NCUA) insures the money deposited.

MMDA Vs. Savings Account: MMDA has a higher rate of interest as compared to a savings account. Unlike savings account, one can withdraw money from a money market account using a check.

MMDA Vs. CD: In case of CDs, or certificate of deposits, the money deposited cannot be withdrawn and the account cannot be closed before the maturity date of the CD. Doing so will result in a huge penalty. In case of MMDAs, limited monthly withdrawals are allowed and a person can close the MMDA any time he wishes.

Risk Involved

Inflation: If inflation is more than the rate of interest earned by the deposit, the account will perform badly.

These accounts are thus, a good investment for people who are interested in earning a competitive rate of interest in a rising interest rate market, without paying a price for liquidity in the short term.
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