New Visitors Privacy Policy Sponsorship Contact Us Media
Baby Boomers Family Green Home and Auto In Critical Condition Just Starting Out Lifestyle Money
- advertisement -
News & Advice Compare Rates Calculators
Rate Alerts  |  Glossary  |  Help
Mortgage Home
Auto CDs &
Retirement Checking &
Taxes Personal

Money market mutual funds aim
for liquid cash, temporary savings

Money market funds Looking for a temporary parking place to keep money in the midst of stock market turmoil? Some financial experts are recommending money market mutual funds.

Since their introduction in the early 1970s, money market mutual funds have grown at a phenomenal rate and are now the investment choice of one in four households, according to Mutual Fund Education Alliance, a Kansas City, Mo. industry trade group.

Credit two reasons for the popularity of this investment tool: Shareholders have easy access to their money, usually through check-writing privileges, plus they get immediate returns in the form of monthly dividends that can be automatically reinvested.

"People look at money market funds as if they are a new investment when the stock market takes a big downturn," says Michelle A. Smith, managing director of the Mutual Fund Education Alliance. "They start looking for ways to get more for their money."

In a time of market volatility, that can mean opting for this conservative investment.

Three ways to earn
For every dollar the shareholder puts in a money market mutual fund, he gets a dollar back plus the interest the money earns from investments the fund makes. Investors can make money in three ways: through income dividends, capital gain distributions and profits from selling shares.

Money market mutual funds can invest in all sorts of things, including U.S. securities such as Treasuries, tax-free instruments, letters of credit and commercial paper -- which are short-term loans to corporations.

- advertisement -

Money can be withdrawn at any time without penalty, unlike certificates of deposit, which require money to be kept on deposit for a fixed period and impose penalties for early withdrawal. Money market funds are managed so that the share price always is kept at $1. This means if an investor deposits $100 into a fund, he is buying 100 shares.

If the securities in the investor's fund earn dividend or interest payments, this money is distributed to the fund's shareholders. Income dividends are distributed on a set schedule -- usually monthly, quarterly, semiannually, or annually. Investors whose goal is to meet current expenses generally arrange to receive this income in cash payments. Those aiming to meet a long-term goal, however, generally arrange to reinvest this income in order to maximize their potential results.

Capital gains distributions occur when a mutual fund sells securities at a profit. These gains are distributed to the fund's shareholders. Again, long-term investors often choose to reinvest this money into the fund rather than receive cash payments.

Risks and returns
Generally, investments offering the potential for higher returns are accompanied by a higher degree of risk, and money market mutual funds are no different. Unlike bank deposits, the Federal Deposit Insurance Corp. doesn't insure money market funds. They are, however, regulated by the U.S. Securities and Exchange Commission, which restricts the type of securities in which fund managers can invest.

"Regulations are stringent on the type of securities money funds can invest in and the icing on the cake is fund companies want to do what it takes to maintain that public confidence," explains Chris Wloszczyna, director of public information at the Investment Company Institute, a Washington- based association representing the mutual fund industry.

Before taking the plunge, investors first should evaluate the goal of a money fund. For example, are potentially higher earnings worth the additional risk of some investments, or is the investor better off sticking with something safer, but earning less return?

Also, is the investor making a short- or long-term investment -- is the income needed now, or is it being saved for a child's education or retirement?

The taxman's cut
Taxes are another consideration. The investor is liable for taxes on dividends, capital gains distributions the fund pays while he own its shares, as well as capital gains the investor realizes when he sells or exchanges shares.

Some exceptions include distributions received in tax-deferred accounts, such as traditional individual retirement accounts, and those funds that provide dividend income that is exempt from federal and state taxes, such as municipal money market funds.

Taxable funds invest in corporate and government securities, and investors must pay taxes on the interest these funds earn. Within the taxable-fund category are government-only funds and general purpose funds that buy a mix of securities. The government-only funds buy only securities issued by the federal government.

Tax-free money funds buy only municipal securities, which means investors won't owe federal taxes on the interest they earn from the fund. Because the interest is tax-free, these funds routinely pay a lower yield than taxable funds.

Getting the facts
Financial counselors advise investors to ask hard questions before buying into a money fund. The fund salesman is required to provide specific answers about the product, its costs and the risks involved. Also, review the fund's prospectus before buying. It will provide information on the fund's goal; how the fund will be invested; what the risks are; the fees to maintain the fund; the manager of the fund; how to buy and sell fund shares; how the fund's distributions are made; how the fund is taxed; and other matters.

"You have to be cognizant of the organization that you have selected to do business with, their expertise and the amount they are currently investing," explains Tim Pillion, senior vice president of global sales at Federated Investors Inc., a New York-based fund investment organization managing $111 billion in assets. "Generally, money funds are safe vehicles."

Pillion adds that because investors have the ability "to move in and out of the fund with out losing any principal gain, it can become a checking account where you can manage household and personal finances."

"Say you get a year-end bonus of $5,000 and you decide to put it in a money fund because you're a little nervous about the stock market; it's the ideal place to park money for the short term," says Wloszczyna, of the Investment Company Institute

Like any bargain, the good ones are worth shopping for. Different banks, brokers and investment houses offer varying interest rates and contract terms. Spend a little time comparing funds to find the deal that's best for you. Lastly, be aware of the following common fees, according to the Consumer Information Center:

  • Front-end loads, which are a straight percentage of the amount, invested -- up to 8.5 percent.
  • Back-end loads, which are paid when the investor cashes in the investment. Generally, the fee will be lower the longer you wait.
  • 12b-1 fees are charges to cover advertising and marketing costs of the fund.
  • Management fees pay for the fund's investment advisers.

The fees associated to maintain a money market fund range on the low end from about $2 for every $1,000 invested to $20 for every $1,000 invested, according to Smith of the Mutual Fund Education Alliance. "Other things being equal, lower costs mean higher returns for investors," Smith says.

Fee shell game
Peter Crane, managing editor of IBC's Money Fund Report in Ashland, Mass., adds that many of the money market funds promoting higher-than-average yields are achieving them by temporarily waiving some of their management fees or absorbing other operating expenses. In fact, up to 60 percent of money funds are doing so, according to Crane.

Why are these funds waiving fees? Apparently to create exceptionally high promotional yields that can be heavily advertised. Then, after the funds attract a large asset base, they will apply their full fees and expenses.

"They are betting on shareholder apathy or ignorance, assuming that when the eventual reduction in yield comes, most investors will maintain their investments in the fund," Crane explains.

To combat this misleading tactic, Crane suggest looking for funds that maintain low expenses year after year, without resorting to short-term tactics to artificially boost yields.

-- Posted: Feb. 2, 1999


top of page
Print   E-mail

Checking and Savings
Compare today's rates
Interest checking 0.34%
MMA 0.39%
$10K MMA 0.35%

  How long will your savings last  
  How to reach a savings goal -- with scheduled payments  
  Watch your savings grow with regular deposits  
Checking Basics
Manage your account in a fee-friendly way.
What's the best checking
account for me?
ABCs of ATMs
What are all these fees?
Is online banking secure?

Banking glossary  
News archive  
Keep an eye on the leading rates  
Find a high-yielding CD

- advertisement -
- advertisement -

About Bankrate | Privacy Policy/Your California Privacy Rights | Online Media Kit | Partnerships | Investor Relations | Press Room | Contact Us | Sitemap
NYSE: RATE | RSS Feeds |

* Mortgage rate may include points. See rate tables for details. Click here.
* To see the definition of overnight averages click here. ®, Copyright © 2015 Bankrate, Inc., All Rights Reserved, Terms of Use.