Market mutual fund stabilize your portfolio during market disarray

These are strictly regulated mutual funds that invest primarily in short-term, top-rated government and corporate securities. Your principal isn't guaranteed, but no one has ever lost money in a money market fund. In addition, money funds can give you a pretty tidy return while allowing fast access to cash you may need in the short term.

But how do you know if money market funds are right for you and, if they are, how do you select from hundreds of funds?

Deciding whether money market funds should be in your portfolio is the easiest step. Certified financial planner Barry Vosler of DeWitt, Iowa, says almost anyone with a savings or investment plan can benefit from money funds, but especially people in two categories.

Individuals going through a life change: "Maybe they're in the early stage of retirement," says Vosler. "We find that in the first couple of years it makes sense to keep more money in a money market fund than you'd typically have in a safety net scenario. In the first couple of years people tend to treat themselves for their hard work -- buy a car, a second home. We see more need for immediate cash on whims."

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People with income needs: "Right now, the income you can get from a money market fund is very comparable to shorter term CDs and better than Treasury markets," according to Vosler. "The money market gives you accessibility and rewards you with a higher rate. Money market funds are also convenient if their income stream isn't predictable from year to year -- maybe there are large unpredictable payments such as medical expenses or long-term care."

If you've decided to invest in money market funds, the next step is figuring out what features you want. Is there a limit on how many checks you can write in a month? What's the minimum amount for which you can write a check? Does the fund provide canceled checks or photocopies? Is there Web site access to your account? Can you transfer money electronically or through a toll-free number?

After finding a variety of funds that have the features you want, take a look at interest rates, minimum initial investments and fees. Bankrate provides rate information on the top money market funds in the country along with an 800 number so you can find out the latest services and features.

Check out the categories
You're also looking at different categories of money market funds -- government, prime and tax-exempt, to name a few. How do you choose? Vosler says he wouldn't focus on that. Since all money market funds have the goal of maintaining a per share price of $1, it's best to focus on yields.

"A dollar earned in one fund is the same as a dollar earned in another. It's the interest rate that counts. If you get peace of mind from a fund that's labeled government, if it gives you the ability to sleep through the night, then go with it."

The difference in interest rates hinges on maturity length and the types of investments that make up the fund.

"U.S. government funds will give you a little lower interest rate than corporate funds right now, but that's not always the case," Vosler says. "From the early '90s through about '97 government bonds were paying significantly higher, about one-quarter percent, than corporate funds -- today it's the opposite."

But there are times when the type of fund selected may make a difference.

Tom Grzymala, a certified financial planner with Alexandria Financial Associates in Alexandria, Va., says he'd be selective if a retired couple wanted a long-term income stream.

Grzymala says his company usually advises a three-year income stream because over the last 55 years the stock market has corrected 14 times and the average length of the corrections is 13 months.

"This way, we have three years protected from the ups and downs of the market," says Grzymala. "The income stream is protected and the rest of the money is working in the stock market."

In this example, Grzymala assumes the couple needs $40,000 per year, so $120,000 will be taken from the stock market and invested in money market funds to cover the income stream.

"The first year's income stream, $40,000, would be in a municipal or taxable fund depending on the income bracket and what the current rates of return are in the money market. Is tax-free going to save money or not?

"The next year's money goes into a high-yield money market fund. It should generally get 30 or 40 basis points higher interest than the first year's money.

"The third year's money goes into a relatively safe, very short-term bond fund."

Taxable or tax-free?
How can you determine whether a taxable or tax-exempt fund will give you a better return? A little math is involved, but a general rule of thumb is to go with taxable funds if you're below the 36 percent tax bracket.

Here's an example. Suppose you're choosing between a 6 percent taxable fund and a 4 percent tax-exempt fund. If your federal tax rate is 36 percent, the 4 percent tax-exempt fund would give you an equivalent taxable yield of 6.25 percent -- therefore, the tax-exempt fund would be better. But if you were in the 28 percent federal tax bracket, the 4 percent tax-exempt fund would give you an equivalent taxable yield of 5.55 percent. In that case, the 6 percent taxable fund would be the better deal. If you pay state income tax, you'll get a slightly different number, but the result should be the same.

Most money market funds are no load, meaning no sales commission, but they all have fees. Fees can affect the yield, so be sure to check the prospectus before handing over your money.