Tax-Exempt Money Funds Still Thrive : Investment: Despite a low average yield of 2%, they remain highly popular as a modern-day savings account.

Although they can’t offer much in the way of returns these days, tax-exempt money market mutual funds have kept an enthusiastic following among investors.

A decade after the first of these funds appeared on the scene, they boast assets of roughly $100 billion, based on a late-April tally by IBC-Donoghue’s Money Fund Report of Ashland, Mass.

That’s about $5 billion more than a year ago at this time--a notable showing when you consider that the funds’ average yield has fallen sharply over the same span, from about 3.1% to right around 2%.

You read that number correctly --2%, a payoff that will be wiped out this year by the erosive effects of inflation on purchasing power, even if Wall Street’s most optimistic inflation forecasts prove correct.

So it’s apparent that people must like tax-exempt money funds for reasons other than yield. One reason, quite evidently, is the exemption the interest they pay enjoys from federal income taxation.

“Tax-exempt frequently means municipal bonds, which are excellent vehicles for many purposes,” says analyst David Skvarla at Kemper Securities in Chicago.

“But suppose you want to be a bit more liquid, tuck away some money you don’t need right now, but be able to get it back again in case of emergency? Maybe you should think about a tax-exempt money-market fund.”

Tax-exempt money funds were born as a kind of best-of-both-worlds hybrid of taxable money funds and tax-free municipal bond funds. Except for the tax break, they closely resemble straight money funds, seeking to keep their net asset values fixed and functioning as cash-management vehicles --or, if you prefer, modern-age savings accounts.

At first, their growth prospects seemed limited by a relative scarcity of municipal money-market securities such as short-term notes and commercial paper issued by tax-exempt entities such as state and local governments. But as the demand for this kind of security became clear, municipal issuers were happy to meet it, since it gave the means of borrowing more money at a lower cost than they would typically have to pay in the municipal bond market.

Today, a prime question facing would-be investors in tax-exempt money funds is whether they can get a better after-tax return there than they could in a taxable money fund.

This is a personal computation for each individual that depends on one’s marginal bracket for federal income taxes.