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Money Market Funds


Money market funds seek income, liquidity, and a stable share price by investing in high-quality, short-term investments (that mature in 13 months or less), including CDs and Treasury bills.

Taxable money market funds pay dividends that are subject to federal, and possibly state and local, income taxes. There are three basic types:

U.S. Treasury Funds.
These funds invest primarily in direct U.S. Treasury obligations whose principal and interest payments are backed by the "full faith and credit" of the U.S. government.

U.S. Government Funds.
These funds invest in high-quality obligations of the U.S. Treasury as well as agencies of the U.S. government. Agency securities are not backed by the full faith and credit of the U.S. government.

General Purpose Funds.
These funds invest in the short-term debt of large, high-quality corporations and banks.

Another category of money market funds-the municipal money market fund-invests in debt obligations of state and local government agencies. These funds provide dividend income that is free of federal (and sometimes state and local) income taxes.

Note that an investment in a money market fund is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The funds seek to maintain a stable $1 net asset value, but there is no assurance that they will do so.


Benefits and Drawbacks of Money Market Funds

Money market funds are low-risk investments that offer low returns in exchange for providing peace of mind.

Benefits of Money Market Funds

Stability of Principal.
Cash investments are viewed as safe because your money generally is invested with reliable borrowers for only a brief period. In addition, the Securities and Exchange Commission requires that all taxable money market funds invest at least 95% of their assets in securities of the highest grade, as rated by Moody's Investors Service, Inc., or Standard & Poor's Corporation.

Current Income.
Dividends, distributed monthly by the funds, typically are higher than the dividends paid by a bank savings account or CD.

Liquidity.
Most of the funds offer free checkwriting privileges, and you can redeem your money at any time.
In addition, tax-exempt money market funds offer the following benefit:

Tax Advantage. Income from municipal money market funds is exempt from federal income tax and, if the fund buys only securities issued in your state of residence, from state and local taxes. As a result, these funds are attractive to investors in higher tax brackets.

Drawbacks of Money Market Funds

Inflation Risk.
Because cash investments are considered safe, the interest rates they pay are low, and over time their returns have only slightly exceeded the rate of inflation. From 1926 through 1998, cash investments returned an average of 3.9% per year while inflation averaged 3.1%, leaving a return after inflation of only 0.8% per year. Therefore, if you have a long-term time horizon, money market funds should not be your primary choice—although they can play a smaller role in a diversified investment portfolio.

Income Risk.
Money market funds hold short-term investments that must be reinvested by the fund manager when they mature-possibly at a lower rate of return.

In addition, tax-exempt money market funds have the following drawback:

Less Current Income.
Because they offer tax advantages, tax-exempt money market funds generally provide less interest income than taxable funds of comparable quality. You can determine which investment is better for you by calculating the tax-exempt fund's taxable-equivalent yield (taxable-equivalent yield = tax-exempt yield ÷ [100% - tax rate]) and then comparing it with the taxable fund's yield.

Note that an investment in a money market fund is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The funds seek to maintain a stable $1 net asset value, but there is no assurance that they will do so.

Money Market Companies


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