I recently received an email from one Stephen A (last name withheld) who asked, “Can you shed more light on the monthly profit calculation of say a N100,000 money market fund investment please?” This question was asked after he read my article titled “Top 10 high-yield money market funds that beat inflation in Nigeria“.
In answer to his question, I decided to write a piece on how you can calculating the interest on your money market fund investment. This article can enable us all to benefit from Stephen’s bold question. So here we go.
Money Market Vs Bonds: Except for floating or variable rate bonds, bonds, unlike money market funds, pay fixed interests based on the coupon rates of the bonds. In that case, you know from the beginning that you will receive N10,000 a year on a 10% coupon bond if you invest N100,000.
On the other hand, money market funds’ interests derive from the yield of the underlying financial instruments such as government-issued instruments like treasury bills, FGN bonds, and from the corporate and state government bonds held by the money market funds. The yield on those instruments change from day to day and as such, money market interests are based on those constantly changing yields rather than on a fixed interest rate.
In addition to the ever-changing yields, money market funds invest in short term securities like treasury bills and commercial papers that mature from time to time and are replaced as they mature by buying newer positions. This buying and selling of short-term financial instruments add to the variability of money market interests. Because of this variability, money market interests are updated as frequently as the fund manager sees fit and possible. While those that can and have the resources to update rates and interests daily based on daily interest adjustment do so, others do so on a weekly basis.
For this article, I will be exploring the daily and weekly calculation of money market interest based on weekly interest rate adjustment. I will also explain the daily interest calculation based on the available daily interest rate.
Quoted or published Interest Rates are Annual: Note that the interest rates or yields you see on the websites of fund managers for their respective money market funds are annual rates, not daily rates. Therefore, the first thing to do in calculating money market interest is to divide the annual rate by whatever frequency you decide to use.
For a daily calculation, divide the annual rate by 365, or 360 (in accordance with appropriate conventions) and by 52 for a weekly calculation. For example, Stanbic IBTC posts the yield on its Stanbic IBTC Money Market Fund on a daily basis and as such, you can calculate daily interest on that. On the other hand, UBA Asset Management Company publishes its prices and yields on a weekly basis and that makes it a candidate for the weekly interest calculation methodology.
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Daily Interest Calculation: Using the Stanbic IBTC Money Market Fund posted yield of 13.01% on February 1st, 2019 as an example, the daily interest comes up to 0.0361%. Having known what the daily interest rate is, the next step is to determine the average balance on your money market account.
The average balance is a combination of your ending balance, plus any new money you put into your money market account, less any money you took out of your money market fund over the period of measurement. The implication of this is that if you do not leave any additional money into your money market account and did not withdraw from the fund, your average balance is your current balance.
Now you have the two most important data required to calculate your interest. So, multiply the average daily balance by the daily interest rate to find your daily interest. For example, using the balance Stephen used in his question, N100,000 and the daily interest arrived at using Stanbic IBTC Money Market Fund February 1st published rate, the daily interest on N100,000 will be N36.14.
Now repeat that process daily for the next 29 or 30 days, adjusting the daily rate with new rates if any, adjusting your daily average balance with any additional money you put in or took out. The sum of the daily interest for any given period, like one month, gives you your interest for that month. Therefore, Stephen’s N100,000 invested in Stanbic IBTC Money Market Fund in February 2019, will generate N1,026.99
Weekly Interest calculation: The weekly calculation is similar to the daily, although there are some added complexities when you add and/or withdraw money within the week. Since the calculation is based on the average balance, to get the correct average balance if you added money within the week, you need to prorate or weight the added money by the number of days it has stayed in the fund for the week.
The same thing happens with withdrawals. For example, if you started out with N100,000 like Stephen hypothesied in his question and 10 days later, you added N10,000 to the fund, your average balance for week 2 is not N110,000 because the additional N10,000 had stayed in the fund for only 4 days of week 2. 4 out of 7 days in a week is 57%. Therefore, 57% of the N10,000 will count towards arriving at the average balance for week 2, which now stands at N105,700. If no other money is added by week three, all the N10,000 will now count towards the average balance which then become N110,000.
In the same vein, if you withdraw, say N10,000, from your money market fund 2 days before the end of the week, two days out of 7 represents 28%. Therefore, 28% of the week, the N10,000 was not there. So, you subtract N2,800 from your average balance for that week’s interest calculation.
Thereafter, if you do not withdraw in the following week, then the remaining N7,200 will be deducted in arriving at your average balance. If both withdrawal and deposit occur within the week on your money market fund, weight each as noted above and add the weighted deposit amount and subtract the weighted withdrawal amount from last weeks ending average balance to arrive at this week’s average balance. Now, multiply the average balance arrived at by the weekly rate to get this week’s interest.
Understanding Interest rate conventions: Interest on interest-paying financial products are calculated based on some laid down conventions, otherwise called day counts. A day count convention is a system used to determine the number of days between interest payment periods. While some use 30/360, others use 30/365, even as others use actual/actual.
The 30/360 convention is calculated by taking the annual interest and dividing by 360 to get the daily interest rate. Then, the daily interest rate is multiplied by 30 to get the monthly rate. Here, the convention assumes that there are 360 days in a year and 30 days in each month. On the other hand, the actual/actual convention divides the annual rate by 365 to get the daily interest rate and multiplies that with the actual number of days in any month, 28 or 29 for February, for example.
From all indications, Nigeria uses the actual/actual convention. However, it does not hurt to find out from your fund manager what convention they use, as that will give a more accurate calculation. Two money market fund investors with different conventions will get slightly different interests each month.
Weekend and Holiday Interests: One good thing about investing is that your money works for you even when you sleep. Therefore, money market funds pay interests on weekends and public holidays at the rate of the day preceding the weekend or holiday. So, your Saturday and Sunday interests will be calculated based on the preceding Friday’s yield or rate. Also, the interest for a holiday that falls on a Wednesday, for example, will be calculated based on the preceding Tuesday’s yield or rate.
I have attached a simple spreadsheet that can help you calculate your money market interest on a daily basis.