Money Funds May Still Make Sense Depending on Your Needs, Goals

There’s nothing like a good stock market slump to make investors appreciate a steady 6% yield.

Money market mutual funds have paid annualized yields in the neighborhood of 6% for most of this year, through the stock market’s wild gyrations. Investors, increasingly looking for safer havens, have responded by pushing money fund assets to $1.8 trillion, a record high.

“I don’t even watch the stock market, but I know it has been going down from all the calls I get” about money funds, says Peter Crane, managing editor of IMoneyNet Inc., a firm that tracks yields on money funds and bank deposits.

But if the Federal Reserve soon begins cutting its official short-term interest rate to help the economy, money fund yields are sure to follow the Fed’s rate lower: Because the funds invest in short-term corporate or government IOUs (generally, debt maturing in less than 90 days), as yields on that paper come down, so will fund yields.

The average maturity of IOUs in money funds now is 50 days, so the funds’ portfolios can turn over quickly.

Of course, many people won’t abandon money funds simply because of lower yields. The funds’ great appeal for the last 30 years has been safety of principal while allowing investors to add to their balance, or withdraw money, without penalty.

If yields are coming down, however, investors are likely to become more aware that all money funds aren’t created equal. Not only do some yield significantly more than others, but there are several variations of money funds available.

To make sure you’re in a fund that best suits your needs, ask yourself these questions:

* Do you want a short-term parking space, or a long-term savings account? If your principal need is for a place to park assets while waiting for a better investment idea, the yield on a money fund may be less important to you than the ability to quickly access the account.

In that case, using the money fund at your brokerage may be the best way to go, even if the yield available is below average. As the story below notes, however, you should check to make sure you aren’t subject to high fees that can negate any interest earned on the fund.

Always ask your brokerage for the best yield available; don’t assume that your cash account automatically earns the best rate.

If you’re using a money fund as a long-term savings account, however--and the balance in the account is large--using a fund that pays an above-average yield probably makes sense.

But note: If you have less than $5,000 in a money fund, spending a lot of time choosing between funds probably isn’t worth your while, because the net difference in annual interest earnings won’t be very large.

* If you’re invested in a high-yielding fund, are you aware of how that yield is earned? Money funds keep their share values stable (usually at $1 a share), and for three decades the industry has almost entirely avoided any mishaps that would cost shareholders principal.

Still, that share price stability isn’t guaranteed, as is the case with bank deposits. If a money fund is paying a high yield, it may be doing so because it’s investing in short-term corporate debt that is lower-quality. The risk of loss on such funds may be minuscule, but it still exists.

If you’re looking for safety first, check the “risks” section in the fund’s prospectus. If it says the fund is restricted to buying only A-1 and T-1 debt, you can feel fairly confident that it isn’t risking your money on speculative debt issues, says John Hollyer, manager of Vanguard’s Prime Money Market fund and a principal at the Valley Forge, Pa.-based fund company.

You also can buy government-only money funds that invest solely in U.S. government or government-agency debt. The current average yield of such funds: 5.83%.

Finally, note that some money funds boost yields by waiving management fees that would otherwise come out of fund assets. That’s good as long as it lasts, but check with the fund to find out if that waiver will expire at a given point.

* Would you benefit from a tax-free money fund? Tax-free funds invest only in the debt of states and municipalities, so the interest is tax-free.

Generally, if you are in the highest federal tax bracket and/or in a upper-middle federal tax bracket but living in a high-tax state--such as California--a tax-free money fund can be worth considering. The yield you earn, while nominally low (the average of all tax-free funds is 3.23% currently) may be worth more than the after-tax yield of a taxable fund.

To determine whether a tax-free fund makes sense for you, divide the tax-free fund’s yield by the inverse of your tax rate. The inverse of your tax rate is 1 minus your marginal tax rate. In other words, if you’re paying 45% of your income in federal and state taxes, subtract 0.45 from 1 to get 0.55.

Divide the tax-free fund’s yield by 0.55 and you get the “taxable equivalent yield” of the fund--the yield you’d need to earn on a taxable fund to equate the tax-free fund’s yield.

* Does your money fund charge extra fees? Don’t be fooled by a fund that has relatively low annual expenses, but charges extra for other commonly used services, such as check writing or balance transfers, Hollyer said. “If they’re charging you a couple bucks every time you write a check, that adds up to a lot of basis points in fees very quickly,” he says. (A basis point is 100th of a percentage point.)

* Do you know how to shop around? The Internet provides fast and easy shopping at two sites: https://www.ibcdata.com offers a money fund selector, where you can view the top funds ranked by yield, safety or tax-exempt status; https://www.mfea.com offers a simple list of the 10 highest-yielding money funds. Both sites offer links to get more information, including minimum investments and toll-free phone numbers, on funds that might interest you.

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Kathy M. Kristof can be reached at kathy.kristof@latimes.com.

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Top-Yielding Money Funds

Here are the money market mutual funds that currently pay the highest yields, according to Imoneynet.com. Most of these funds boost their yields by waiving a portion of the fund’s management expenses, though the funds generally don’t guarantee that the waiver will continue indefinitely.

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*7-day yields Money market fund Simple Compound Toll-free phone Strong Investors 6.52% 6.73% (800) 368-3863 OLDE Premium Plus 6.49 6.70 (800) 872-6533 Aon Funds 6.46 6.67 (800) 266-3637 Zurich YieldWise 6.43 6.64 (888) 523-4140 Transamerica Premier Cash 6.41 6.62 (800) 892-7587 INVESCO Treasurer’s 6.40 6.61 (800) 525-8085 TIAA-CREF Money 6.39 6.59 (800) 223-1200 Bunker Hill 6.37 6.57 (800) 572-9336 Scudder Premium/AARP 6.35 6.55 (800) 225-5163 Scudder Premium/Class S 6.35 6.55 (800) 225-5163 Money fund average 6.01 6.19

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Source: Imoneynet.com