Dear Dr. Don,
What is the rule for determining when to invest in a tax-free money market mutual fund versus a taxable account?
-- Ed Elucidate

Dear Ed,
The key is to put the two yields on an apples-to-apples basis. The easiest way to do that is to convert the tax-free yield to a taxable equivalent yield. The other thing to remember is that money market mutual fund yields are seven-day yields, meaning they give you an annualized rate of return based on what the portfolio has been earning over the past seven days. Comparing the returns net of fees is also important.

You need to be conversant in the applicable tax laws of your state and local government to get this right, because while the feds won't tax the interest income of state and local government debt, not all states or local governments exempt this income from taxation.

If you're a New York City resident investing in New York City debt, for example, you get a triple play because the interest income isn't taxed at the federal, state or local level. Not all states and localities are as enlightened, and most states are positively provincial about municipal interest income earned on out-of-state debt.

The math isn't that hard, but it's easiest to use a Web-based calculator, such as the one on CNNMoney.com.

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