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Money market funds, not to be confused with money market accounts, are securities that can be purchased through most brokerage accounts or directly from certain financial institutions. These funds exist in both a fully taxable variety as well as a tax-free variety. It is best to think of these funds as mutual funds with holdings made up primarily of short-term, high-grade debt obligations and cash-on-hand to ensure liquidity. It is important therefore to realize an investor receives no guarantee that principal invested in the fund will not fall below par value (in other words, a dollar invested may at some point be worth less than a dollar).
| Fund Name | 7-Day
Trailing Yield*** (%) | WAM
(days) | Assets ($mils) |
Min Investment |
| Fidelity Cash Reserves | 2.55% | 42 |
120819.1 | $2,500 |
| Morgan Stanley ActiveAssets MT | 2.39% |
69 | 5651.1 |
$5,000 |
| Dreyfus |
2.38% | 69 |
1213.8 | $25,000 |
| Western Asset MMF/Cl A | 2.35% |
65 | 30940.2 |
$500 |
| PayPal** |
2.34% | 55 |
5755 | $1 |
* Please note that this table only examines best current rates for fully taxable retail money funds. Institutional money funds - those requiring minimum deposits of $1 million to $10 million - may exceed the best rates of the best performing retail money market funds. Currently, the best available institutional rate is approximately 2.66% in a Citibank product with a $1 million minumum.
** The PayPal Money Market Fund is a feeder fund for a Barclays managed fund which has a $10 million minimum deposit; PayPal takes a 2 basis point (.02%) commission.
*** The 7-day trailing yield differs slightly from an Annual Percentage Yield (APY) (see the Financial Terminology section) upon which banks are allowed to market savings accounts and CD products. Since the 7-day trailing yield does not assume compounding of the interest paid over the seven days, the actual APY would, assuming rates were to stay constant, ordinarily be approximately 6 to 10 basis points (.06% to .10%) higher.
Since money
market funds are not FDIC insured, there is no government guarantee of a return
of principal. However, these funds are regulated under Rule 2a-7 of the Investment
Company Act of 1940 which regulates mutual funds. Moreover, fund managers are
bound by fund rules to invest in short duration securities (ordinarily less than
180 days) of specified credit rates in order to safeguard principal and ensure
shareholders' liquidity.
Rates are generally quoted in terms of a seven-day
trailing performance, since there is no guarantee of future performance.
Please note that these funds differ significantly from closed-end bond funds and
are not an investment that will appreciate in value as interest rates decline.
Fully taxable money market funds are funds that produce interest that is fully taxable to US taxpayers, and therefore produce income that is treated akin to online savings and money market accounts and short term certificates of deposit. Unlike tax-free money market funds (see below), fully taxable money market funds have underperformed these alternatives over the last several years, and continue to do so. Management fees have eroded the already low amount of interest on short term instruments. As short-term rates rise, there is some hope that money market funds will be more competitive with other liquid financial instruments. However, it is likely that rising short-term interest rates will show up more quickly in higher yield in other instruments, such as auction rate securities (since money market funds have securities with maturities that may extend out for up to 180 days).
Tax-free money market funds are generally composed of municipal bonds are are exempt from federal tax. They are also state and local tax free to residents of the state that has issued the underlying bonds. Vanguard (which has a $3,000 minimum balance), for example, has tax-free money market funds for residents several different states, all of which yield between 2.75% and 3.10%. Vanguard's tax-free funds are considered very attractive, in part, due to their low expense ratios, which are ordinarily around 0.13%.
For those in the highest federal tax bracket (35%), interest earned in certain tax-free money market funds is equivalent to a fully taxable yield in excess of 3.50% if they also happen to live in a state and locality with high income taxes. For example, a resident of New York City (one of the highest taxing localities with local and state taxes at 12.15%) in the highest local and state and federal brackets would find that the Vanguard tax free fund would yield the a taxable equivalent around 3.80%. Even if you are not in the highest federal tax bracket, you may still outperform taxable cash equivalents through these money market funds.
Please note that the rates of tax-free money market funds tend to vary dramatically from week to week.
Compare fully taxable equivalent of a municipal bond in your state and tax bracket.
What
to Look for:
Compare management fees, which are calculated and
reported in terms of expense ratios. Expense ratios tend to range between 0.10%
and 0.50%. Over any length of time, those funds with the lowest management fees
tend to outperform those with higher fees.
Check the rules of the fund's
prospectus carefully to see what rules bind its managers. Be sure that the fund
invests only in the highest rated debt securities and that it maintains a certain
amount of cash on hand to pay shareholders who are selling their shares.
Those funds with lower weighted average maturities (WAM) which is measured in
terms of days will generally outperform in rising interest rate environments,
and underperform in declining interest rate environments.
Certain funds
require minimum balances, require that additional deposit be of certain sizes
and limit withdrawals. Try to avoid investing in funds that limit your ability
to buy and sell shares quickly.
