Are High-Yield 7-Day Money Market Accounts Too Good To Be True?

Question

When you have accounts offering up to 4% PER WEEK, why doesn't everyone just use these accounts?

The compound interest with a year of utilizing these accounts is insane!

Are they too good to be true?

What are the risks, because I've never heard of a Money-Market account going belly up.

Answer 1

7-Day Annualized Yield

What It Is:

The 7-day annualized yield is a measure of the yearly rate paid to investors of an interest-bearing account, based on the returns earned in a 7-day period.

The formula is:

7-Day Annualized Yield = ((A-B-C)/B) x 365/7

Where:

A = The value of an account at the end of the 7-day period

B = The value of an account at the beginning of the 7-day period

C = A proportional week's worth of fees (if fund fees vary with the size of the account, assume the account is equal to the fund's mean or median account size)

How It Works/Example:

Let's assume Company XYZ money market fund needs to calculate its 7-day annualized return. If one share of the fund was worth $20 at the beginning of the week, $20.05 at the end of the week, and one week's worth of fees totaled $0.04, then by using the formula above, we can calculate that the XYZ fund's 7-day annualized yield was:

Yield = (($20.05 - $20- $0.04)/$20) x 365/7

= 0.02607 or 2.61%

It is important to note that the SEC strictly defines the 7-day annualized yield formula and use. It also provides strict guidelines for calculating the effects of dividend reinvestment, realized gains and losses, nonrecurring fees, and dividend taxes.

Why It Matters:

The 7-day annualized yield gives investors a way to compare interest-bearing accounts' returns. The measure tells investors what the fund would yield in a year if it continued on its current earnings path. Without this and other standardized, required disclosures, accounts could manipulate their yield calculations.

It is important to understand that the 7-day annualized yield is not the same as the 7-day effective yield. The 7-day annualized yield merely annualizes the simple yield. The 7-day effective yield is usually a little higher because it assumes income from the fund is reinvested (i.e., it compounds).

Answer 2

I have never heard of a money market account going "belly up."  

However, they have done what's called "breaking the buck."  

A money market mutual fund typically attempts to hold the price per share steady at $1 per share and the interest rate fluctuates constantly.

When a money market fund "breaks the buck," the price per share closes below $1.  It has happened, and it has happened this year.

I have not heard of a high-yield 7-day money market account such as you describe.  I HAVE heard of similar investments that offer 3% or 4%; but typically there is a minimum investment, often of $1 million or more.  And the 3% or 4% is not what you get paid per week; it's an annual rate, and in a week you would earn 1/52 of that amount.