Money market funds have existed for more than 35 years, revolutionizing the way investors hold cash. Paying much higher interest rate than most banks, savings accounts, they helped investors keep pace with high inflation in the 1970s. Recently, however, banks fought back with high-interest savings accounts that pay competitive prices are sometimes higher than the typical money market fund. These accounts have landed a knockout punch on money market funds, but we will see that money markets are not down for count yet.
Particularly money market funds still have a leg up on bank products such as savings accounts and CDs. With the combination of several investment choices and flexibility in transferring money between your investments, money market funds can still play a vital role in your overall portfolio.
More choice
Money market funds come in several different types and can be broadly defined into two categories: taxable and tax exempt. While savings accounts and CDs are always subject to federal income tax, tax-exempt money market funds have short-term municipal debt, there are usually tax free. Although the stated rate of return on these tax-exempt funds are lower than their taxable counterparts, their after-tax returns are often higher, especially if you are in the highest tax brackets. Depending on what state you live in, you may be able to find a money market fund that is tax free for state income tax as well.
Among taxable money market funds, there are several subcategories. Some funds, for example, hold only short-term Treasury bills. These funds are the safest, and their income is usually tax for the state - but not federal - income tax. Other funds have debts of state-sponsored bodies such as Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: Fri), which is not necessarily as safe as treasuries. These government money market funds pay higher rates than Treasury funds, but they often do not qualify for the same state income tax breaks. Still other funds have short-term corporate debt. These funds typically have the highest employment rates, but they also carry a higher default risk.
More flexibility
Besides the larger number of choices for investors, money market funds offer investors greater ease in moving their money than savings accounts. Most money market funds offer check-writing, which gives investors instant access to their money, simply by writing a check. Additionally, you can transfer money between your money market fund and your bank account, and exchange money market shares for equity and bond market mutual funds offered by the same company.
In contrast, money in a savings account can require several steps to get it where you want it. While high yield savings accounts offer direct links to other bank accounts, you will often need to arrange for a transfer and then wait for that to take place before writing a check or make a further electronic transfer to their final destination. And while CDs sometimes offer better prices, they are not easily available at any time without penalty.
Best Rates
You'll typically find deals from popular donors Fidelity and Vanguard, among the top manufacture of mutual funds in each category. For example, peaks Vanguard Prime Money Market Bank Rate this week's list with a yield of 5.22%. Fidelity's Cash Reserves and Government Reserves check-in at 5.09%. Among tax-exempt money market funds Alpine Municipal leads the field with a 3.91% yield, followed by Vanguard's tax-exempt fund at 3.87%.
That the short-term savings are crucial for a successful financial plan. You can learn more about money market funds and other savings options in our Savings Center. On the other hand, if you are looking for ways to find cash to put into your savings to consider taking a free trial of our personal finance service, Motley Fool Green Light. Each month you get new tips, where you can pay less or save more. Before you know it, you have plenty of money, regardless of the savings vehicle you choose.
Best Money Market Funds
