Hannah BrooksWhy the monthly contribution beats the starting balance
Why the monthly contribution beats the starting balance
Say you've only got $1,000 to put in. Run that through a calculator on its own at 4% APY for five years and you'll get a number that probably won't impress you — somewhere just over $1,200. Now add $50 a month. That gets you to roughly $4,500. Push it to $200 a month and you're at about $14,500 after the same five years.
The starting balance ends up being a rounding error by year five. Almost everything is coming from the recurring transfer. Most articles about saving skip past this because there's nothing dramatic about "set up a $50 autopay and forget about it," but that's basically the whole game.
Compounding (the part that's less impressive than you think)
Compound interest gets oversold. Yes, the interest your money earns starts earning its own interest, and yes that's the snowball thing everyone talks about, but at the actual rates banks pay, the snowball is rolling pretty slowly down a fairly flat hill.
Compounding frequency is the part of compounding that occasionally matters. Banks compound either yearly, monthly, or daily, and the difference is real but small. If you park $10,000 at 4% for five years, you end up with about $12,167 on a yearly schedule, $12,210 monthly, and $12,214 daily. So the entire spread between the worst and best schedule is around $47 over five years on a $10,000 balance. Worth noticing in the fine print. Not worth switching banks for.
APY versus interest rate (the gotcha)
Banks sometimes advertise two rates side by side: a nominal interest rate and an APY. The APY is the one that includes compounding, which is why it's always a bit higher. When you're comparing offers, the APY is the number you want, because it's closer to what your balance actually looks like after twelve months.
If a bank is only quoting the nominal rate without an APY, that's strange and you should ask why.
Minimum balances and tiered rates
Most money market accounts only pay the advertised rate if your balance stays above some minimum. Drop below it and one of two things happens — either your rate falls off a cliff, or you start paying a monthly maintenance fee that erases a chunk of your interest. Either way, the headline APY isn't really the APY anymore.
Tiered rates make this messier. Plenty of banks pay almost nothing on the first few thousand dollars, a competitive rate from somewhere around $5,000 up to $25,000, and the headline rate only kicks in above $25,000. So if you're putting $4,800 into an account because you saw "4.5% APY" in the ad, double-check whether you're actually earning 4.5% or whether 4.5% is the top-tier rate sitting on a tier you'll never touch.
I keep a small buffer above whatever threshold I'm trying to clear. One unexpected expense that drops you into a lower tier for a single month can cost more than the buffer was holding you back from spending.
FDIC and NCUA
If the bank is FDIC-insured, or NCUA-insured for credit unions, your deposits are covered up to $250,000 per depositor, per institution. The two agencies cover the same amount and basically work the same way for our purposes. Verify this before you open anything — it should be obvious on the bank's site, and if it isn't obvious, walk.
Transaction limits
Money market accounts used to be capped at six "convenient" transfers per month under federal Regulation D. The Fed officially relaxed that rule in 2020, but most banks still enforce their own version of it. Going over the cap usually costs you a fee in the $10 to $15 range per excess transaction, and if you make a habit of it, the bank can convert your account to a regular checking account, which defeats the entire point.
So don't use an MMA as your everyday spending account. Use it as a holding tank.
Worked example: a car down payment
Suppose you want $10,000 for a down payment in two years. You start with $2,000 and find an account paying 4% APY.
Run the numbers and you'd need to contribute about $315 a month. After two years, you'd have a bit over $9,500 from contributions plus a few hundred dollars in interest. Not life-changing money, but also money you didn't have to earn at work.
Worked example: a six-month emergency fund
If your essential monthly expenses run $3,000, a six-month cushion is $18,000. Starting with $1,000 and contributing $400 a month at 4.5% APY, you'd hit that target in a little over three years. The account would throw off something in the neighborhood of $1,200 in interest along the way — call it two weeks of expenses covered by the bank.
This is the case where an MMA actually earns its keep. Money you might need in an emergency shouldn't be in stocks, and it shouldn't be sitting in a 0.01% checking account losing ground to inflation. An MMA is the right tool for this specific job.
Taxes
Interest income is taxed as ordinary income at the federal level, and your bank will send you a 1099-INT if you earned more than $10 in a given year. So when your calculator tells you you'll earn $1,200, the cash you actually keep depends on your bracket. At 12% you'd net a bit over a thousand. At 22% it's closer to $940. Some states tax it too.
Worth knowing. Not worth obsessing over.
Inflation
This is the one most savings articles wave at without really engaging with. If your account earns 4% APY and inflation is at 3%, your real return is 1%. The number on your screen grew. Your purchasing power barely did.
Why an MMA isn't a wealth-building account
Money markets are roughly keeping pace with inflation at the moment, sometimes a little ahead, but that hasn't always been the case and there's no reason to think it'll stay that way. The point of an MMA isn't to build wealth — it's to keep your emergency fund from quietly shrinking while you're not looking. If you're trying to build wealth, you want a brokerage account, not a money market.
Comparing offers
The two things I actually pay attention to when comparing accounts are teaser rates and the fine print on the headline rate.
Teaser rates are the promotional APYs that look great in month one and quietly fall off a cliff in month four or seven, depending on the bank's promo period. The rate you care about is whatever you'll be earning a year from now, not whatever's in the ad copy.
The fine print on the headline rate is where the actual gap between accounts hides. A 5% APY that requires a $50,000 minimum and ten debit-card transactions a month and direct deposit isn't really a 5% APY for most people — it's a 5% APY for people who already have $50,000 lying around and are willing to jump through hoops for it.
What I actually look at when I'm sizing up an account is the rate I'd be earning a year in, after any promo period has lapsed, and then the conditions attached to it. The minimum balance is the big one because that's where most of the surprise costs come from. Fees only matter if you slip below the minimum, but if you slip below the minimum you're probably also losing the high rate, so it stacks. The last thing I think about is whether getting money in and out is going to be a hassle, because if it is, I'll end up not using the account properly anyway.
On not doing anything
Procrastination has a price tag on this one. Ten thousand dollars sitting in a 0.01% account for a year while you keep meaning to move it works out to about $400 in interest you didn't earn — money that's just gone, in the sense that you're never getting it back. Switching banks is annoying, I know. Most people I've talked to about this put it off for months for reasons that are basically "the new account login flow looked tedious." Fair enough. But the annoyance of switching is a fixed cost you pay once, and the cost of leaving the money where it is gets renewed every single month you don't deal with it.