What to Know About Money Funds

What to Know About Money Funds
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The Associated Press
Updated:
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By Ella Vincent From Kiplinger’s Personal Finance

The run on Silicon Valley Bank and the cascade of bank troubles in March spooked depositors, who withdrew billions of dollars from bank accounts. Much of their money ended up in money market mutual funds. Investments in money funds skyrocketed by about $67 billion during the first three weeks of March, according to the Investment Company Institute.

Money funds hold low-risk, short-term investments, such as Treasury bills and other government securities, commercial paper, and certificates of deposit. Although money funds are relatively safe, they are not as safe as their bank-version equivalents—money market deposit accounts (MMDAs), which are insured by the Federal Deposit Insurance Corp. (Money market funds are considered securities and are protected by SIPC insurance.)

For emergency savings or other cash that needs to be safe and readily accessible from your bank, a money market account makes sense. Money that you may want to quickly move into the market—say, to scoop up stocks at low prices during a dip—is often best parked in a money fund linked to the rest of your investment portfolio.

But if you’re holding extra cash these days, a money fund may be a good place to earn extra yield. Money fund yields react more quickly than bank accounts to Federal Reserve interest rate hikes, and it’s easy to find yields north of 4 percent.

“Money market funds are more sensitive to interest rate fluctuations than other types of investments,” says Jordan Gilberti, a certified financial planner at Facet Wealth Management, in Baltimore, Maryland.

While the average yield on MMDAs was recently 4.57 percent, according to the FDIC, “prime” money funds recently averaged 4.65 percent, according to the Securities and Exchange Commission.

There are three kinds of funds: prime, government, and municipal. Prime money market funds are invested in cash and corporate notes. Government money market funds invest in government debt securities, such as Treasury bills and bonds.

The third kind, municipal money funds, are usually exempt from federal taxes, and sometimes state taxes. If you’re in one of the top federal income tax brackets and live in a state with high income taxes, you may come out ahead with a tax-free fund. Look at the taxable-equivalent yield—the yield you’d need to earn on a comparable taxable fund after paying taxes to match the yield of the tax-free fund. If a tax-free fund yields, say, 2.4 percent, that’s a taxable-equivalent yield of 3.8 percent for an investor in the 37 percent federal tax bracket.

No matter which type you choose, look for a combination of high yield and low expenses. For example, Vanguard Federal Money Market (Symbol VMFXX, Yield 4.8 percent) has an expense ratio of 0.11 percent, meaning you pay $11 for every $10,000 invested.

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