What money market funds can do

MUTUAL FUNDS

May 01, 1994|By WERNER RENBERG | WERNER RENBERG,1994 By Werner Renberg

Remember money market mutual funds?

They were the funds that caught your eye 10 years ago because they gave you access to the 10 percent yields prevalent in money markets while federal bank regulations kept you from earning more than 5.5 percent on a savings account.

They also were the funds that you abandoned a year or two ago because those yields had fallen to 3 percent and below -- and you thought equity and bond funds would be more profitable.

That probably was a smart move. Equity and bond funds have held -- and still hold -- greater promise as long-term investments.

But, inasmuch as the Federal Reserve has been raising short-term interest rates and may continue to do so until it's satisfied that it has aborted serious future inflation, you may wish to reacquaint yourself with money market funds and what they can do for you.

The average yield of taxable money market funds is above 3 percent again, according to IBC/Donoghue's Money Fund Report -- matching nearly two-thirds of the 0.75 percentage point increase in short-term rates brought by the Fed since Feb. 4. It may continue to rise slightly as fund managers buy new securities issues.

That still doesn't make them as attractive as long-term investments. They barely manage to stay ahead of current inflation and, in taxable accounts, have tended to produce negative real returns after taxes.

But, nevertheless, they may have a role in your strategy. Even if you don't need a money market fund for reserves because you have a short-term bond fund for this purpose -- and if you're not one of those redeeming some bond or stock fund shares because of recent market volatility -- you may wish to use one as a "parking lot."

You may be getting a large sum -- whether from an employer's plan, a property sale, or an inheritance -- that you want to invest for the long-term in equity and bond funds but you haven't yet selected the funds. You can simply put it into a money market fund, then feed it into the funds that you pick.

You also can use a money market fund as you approach the time when you have to take money out of your long-term funds and don't want to risk the markets being down when you redeem.

L What, then, should you know about money market mutual funds?

* Beyond the usual mutual fund structure, they have at least one thing in common: They invest in portfolios of debt securities whose weighted average maturities can't exceed 90 days and which are managed to maintain a stable net asset value (NAV) of $1 a share.

Regardless of whether you buy shares from a bank or the assets are invested in Treasury securities, the U.S. Government does not guarantee that $1. Its stability depends on how funds are managed.

* There are two basic types of money market funds: taxable and federally tax-exempt. If you're in the 28 percent federal tax bracket, you may be better off in a tax-exempt fund (despite its lower yield) when it would provide you more cash than a taxable fund after taxes.

This isn't one of those times. On April 26, the average compound 7-day yield for taxable funds was 3.18 percent, according to Money Fund Report. If you're in the 28 percent federal tax bracket, that would leave you 2.29 percent --a bit more than the 2.20 percent average yield for tax-exempt funds.

* Taxable funds are further divided into those that are limited to U.S. Treasury securities, those that also buy issues of government agencies, and those that buy obligations of corporations.

* Money market funds' expenses have absorbed a greater share of their investment income as it has fallen with interest rates. In the past five years, as average total returns fell from nearly 9 percent and 6 percent for taxable and tax-free funds, respectively, to around 2.5 percent and 2 percent, their median expense ratios stayed at 0.65-0.75 percent of average net assets, Lipper Analytical Services reports.

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