Making The Most of Money Market Funds

by Alan Lavine and Gail Liberman

Confused about what to do with your cash?

If interest rates keep rising, money market mutual funds become attractive. But as with any investment, it pays to know how to get the most bang for your buck.

Money market funds invest in short-term debt instruments that typically mature in 90 days or less. Investments generally include U.S. Treasury bills; bank CDs; commercial paper which are corporate I.O.U.s; and/or dollar-denominated CDs of foreign banks.

Money market funds, while not U.S. government guaranteed, have a special accounting system to keep their share price at $1, which means you should not lose principal. By contrast, when interest rates rise, bond prices fall. Be advised, however, that there have been times when money funds have had to kick money into a fund to keep their net asset values at $1.

Money fund managers keep the average maturity of their investments short when they think interest rates will rise.  

If short-term interest rates keep rising, you should earn higher yields in a money fund compared with U.S. Treasury bills or three-month bank CDs.

It’s best, though, to invest in low-cost money market funds. The average money fund charges about one-half-of-one percent annually to manage the fund.

Here are a couple of tips on how to invest in money funds.

• Avoid ultra short term bond funds. These funds invest in securities that mature in more than 3 months. The reason: The price of the bond fund will fluctuate with interest rates. When interest rates rise, the value of your bond fund may be down a couple of percentage points.
• Stick with money funds that are part of a large mutual fund family or a discount brokerage firm’s mutual fund supermarket. The reason: You can invest in other types of mutual funds when the right situation arises.
• Stick with tax free money funds if you are in a high tax bracket.
• Park your cash in money funds that keep their average maturities very short. This way, the fund manager can roll money over quickly to catch higher rates.

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "Rags To Retirement," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show. Al and Gail’s new book is "Rags To Retirement:  Stories from people who retired well on much less than you think," published by Alpha Books.

More articles by Al and Gail can be found here.