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  CDs and Investing Basics   Chapter 1: Building liquid savings
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Money market funds

 

Banks, brokerages and mutual fund companies offer money market mutual funds (MMF). They're most commonly used by people with brokerage accounts who sell a stock and then put the proceeds in a MMF until they decide where to reinvest the cash. But these funds can be used to build cash for an emergency fund or other short-term goals.

At a glance
Money market funds are not FDIC insured, even if you open an account at a bank, but if you're willing to take just the slightest bit of risk with your liquid savings, check them out because they pay a better rate than a basic bank money market account (MMA.)

The reason it's OK to take on the risk is because MMFs are highly regulated and invest in very safe, short-term debt securities such as certificates of deposits and U.S. Treasury bills. The funds try to maintain a share price of $1. There's no guarantee a fund will be able to maintain the share price, but no consumer has ever lost money in one of these funds.

Money market funds

High yield MMAs
Since someone is paid to oversee the fund and manage the investments in it, you'll pay a fee called the expense ratio, which helps pay the cost of running the fund. The advertised yield has already had the expense ratio deducted. Fees reduce the yield so it's always important to look for a fund with a low expense ratio. Vanguard has a reputation for having some of the lowest fees around. If they're charging an expense ratio of .30 percent, it's fair to assume that the industry average is perhaps .50 percent. You'd want to avoid funds charging much above that. You can find the expense ratio information in the prospectus and on many brokerage or stock Web sites.

Money market funds are divided into two categories, taxable and tax-free. Taxable funds usually pay a higher yield, but that doesn't always make them a better deal. If you're weighing a taxable fund against a tax-free fund, you'll need to do some math called the tax-equivalent yield formula to see which will give you the better return.

Money market funds allow you to write checks and make electronic transfers, but most accounts establish a minimum dollar amount. Electronic, telephone and pre-authorized transactions are limited by federal regulations to six per month, with no more than three being by check, draft or debit card. Check with your institution to see if it imposes a fee after a certain number of withdrawals if your account balance drops below a certain level.

-- Posted: May 1, 2006
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